Hedgeye CEO Keith McCullough shares the top three things in his macro notebook this morning.
Takeaway: 1Q15 is shaping us as a mixed bag, but may be P's best print this year. The setup gets progressively worse from here.
- 1Q15 = MIXED BAG: We’re expecting upside to revenues on light 1Q15 guidance and corresponding consensus estimates. However, we’re expecting user metrics to disappoint on heightened expectations following P’s accelerating user growth off a depressed comp. We definitively can’t say what is more important for the stock this quarter, but historically P needs to win on both fronts to appease the street.
- SETUP GETS WORSE FROM HERE: After 1Q15, the setup deteriorates through the year. We suspect revenues could disappoint in 2H with consensus calling for accelerating ad revenue growth through 2015. Further, as we move through 2015, the prospect for declining users grows, and the overhang from Web IV will intensify.
- WHAT WE’RE KEYING IN ON: Listener Hours. Web IV is all that really matters now, and we expect P will lose the one debate that it can’t on royalty rates (bifurcated structure). Given the potentially significant increase in rates, the more hours P enter 2016 with, the more bearish we become (as perverse as that sounds). The situation would be far too sensitive to just apply a simple listener cap, and hope it would suffice (see table below). P would need to take more drastic steps to reign in content costs
1Q15 = MIXED BAG
Management issued particularly light 1Q15 revenue guidance, implying nearly 10 percentage points of deceleration in y/y revenue growth from 4Q14 to 1Q15 (from 33% to 24% at the midpoint of guidance). We’re expecting 29% revenue growth (vs. consensus of 25%) given continuing strength in local advertising and the embedded y/y tailwind on its higher-ARPU subscription product from the 25-33% price increase late in 1Q14.
However, we are expecting user growth to disappoint. We believe consensus is putting too much stock into P’s 4Q14 acceleration, which came off a particularly weak comp. In 4Q13, P experienced its worst deceleration in y/y active listener growth in its reported history following its redesigned ad feed late in 3Q13 (switched from single to double ad feed, and increased max ad load from 4 to 6). The other thing to consider is that the first quarter is seasonally slower. We don't believe P can sustain +80M active users that the street is expecting.
SETUP GETS WORSE FROM HERE
1Q15 may be P's best release of the year. We’re expecting revenues could disappoint in 2H with consensus calling for accelerating ad revenue growth through 2015; a situation that essentially requires accelerating growth in P's two competing growth drivers (Ad-Supported Listener Hours and Advertising RPMs).
But the two more important headwinds are Web IV and Active User growth. We expect Web IV to increasingly dominate the story as we draw closer to the CRB decision (expected by Dec 15th). We also expect active users to decline on a y/y basis in 2H15.
Regarding users, we estimate that P’s remaining TAM isn’t large enough to offset its heightened churn issues for much longer, and as we move closer to year end, penetrating what remains of P’s TAM (mostly older) will become more challenging. For more detail, see the note below.
P: New Best Idea (Short)
12/22/14 03:56 PM EST
WHAT WE’RE KEYING IN ON
Listener Hours. Our focus moving forward is Web IV. We’re expecting P to lose the one debate that it can’t on royalty rates (different rates for ad-supported vs. subscription music). If that winds up being the case, P could see a crippling increase in ad-supported royalty rates, and the more listener hours P enters 2016 with, the greater the profitability squeeze that would occur.
The obvious question is why we’re considering revenue as a secondary read. The reason is that P’s revenue growth has been largely driven by a ramping investment in it’s a salesforce, with S&M expenses growing as a percentage of annual revenue since 2012. If Web IV goes against P, its ability to continue investing in its salesforce would be limited at best, if not entirely dependent on managing its listener hours.
In short, the best case scenario for P would be if user/hour growth decelerates as we expect this year. If not, the situation would be far too sensitive, and P would have limited wiggle room to get this right (see table above). P would not have the luxury of applying a simple listener cap, and hoping everything turns out ok. P would need to take more drastic steps in 2016 to reign in content costs.
Let us know if you have any questions, or would like to discuss in more detail. For Web IV supporting analysis, see links below.
Hesham Shaaban, CFA
WEBCASTER IV NOTES
P: Losing the Critical Debate?
04/08/15 08:53 AM EDT
P: Worst-Case Scenario? (Web IV)
03/23/15 09:30 AM EDT
P: Webcaster IV = Powder Keg
01/13/15 02:49 PM EST
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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 here. Encourage 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.
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.
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.
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.
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.
Client Talking Points
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 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%).
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.
|FIXED INCOME||30%||INTL CURRENCIES||6%|
Top Long Ideas
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.
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.
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.
QUOTE OF THE DAY
Most great people have attained their greatest success just one step beyond their greatest failure.
STAT OF THE DAY
Mobile searches related to mortgages, credit cards, loans and life insurance are gowing 48% year-over-year.
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