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CAT: Cat Financial & 10-Q Review

Overview

 

CAT shares have outperformed since we removed CAT as a short from our Best Ideas List in late January 2015.  However, we are interested in adding short CAT back to the list, and have focused on potential losses at Cat Financial as a downside catalyst.  While we think CAT may beat and raise guidance again in the 2Q15 report, the second half of 2015 should bring much weaker results.  We estimate that CAT’s 2H15 EPS will annualize to ≤$4.00 vs. 2016 consensus of $4.79.  An increase in Mining past dues was a key takeaway from the 1Q15 release.

 

Losses at CAT’s captive finance subsidiary, a much lower EPS run rate, and uncertainty surrounding investigations/control issues may result in significant pressure on the shares later in 2015. 

 

Cat Financial’s portfolio exposure to mining, coal, and upstream oil & gas producer defaults is hard to estimate given the current disclosures.  While Cat Financial does not provide much detail on specific credit exposures, its marketing ‘pitch books’ do name some names.  One important incremental piece of information is that Cat Financial does not appear to have any Export Import Bank (Exim) guarantees on these exposures.  So Cat Financial would appear to be on its own should it retrieve collateral from Boseto, Kaunisvaara, and other troubled projects.  

 

CAT: Cat Financial & 10-Q Review - 1p

 

 

These deals may have made more sense in the 2007-2012 commodity price environment, but we wonder if Cat Financial was underwriting the equipment instead of the borrower.  Remarketing repossessed mining equipment in the current equipment demand environment is unlikely to be easy, and repossessed equipment can compete with already depressed new equipment and parts sales. The recognition of these credit troubles seems likely to hit later in 2015.  This should coincide with the step down in earnings as CAT's oil & gas backlog runs dry. 

 


As for the 10-Q, there is quantification of the increase in past dues, an incremental subpoena, and a slight tailwind year-on-year from warranties:

 

 

Mining Past Dues:  Management noted that past due receivables picked up in 1Q 2015, but the magnitude of the increase is noteworthy.  Mining past dues were $39 million at year end 2014, but nearly tripled to $106 million during just the first quarter of 2015, and were up nearly 10x year-over-year.  While the scale is still fairly small, we expect the ramp to continue during 2015.  We also understand that some mining exposure is under the regional categories, as is Cat Financial’s upstream oil & gas exposure. The allowance for credit losses declined very slightly during the quarter.

 

CAT: Cat Financial & 10-Q Review - po2

 

CAT: Cat Financial & 10-Q Review - po3

 

 

Another Subpoena: Realistically, CAT can afford both the legal fees to keep these issues in court, and to pay whatever fines are needed to exit these investigations.  It is a distraction for management, investors, and interested customers, however.

 

“The Company received an additional subpoena relating to this investigation requesting additional documents and information relating to, among other things, the purchase and resale of replacement parts by Caterpillar Inc. and non-U.S. Caterpillar subsidiaries. The Company is cooperating with this investigation. The Company is unable to predict the outcome or reasonably estimate any potential loss; however, we currently believe that this matter will not have a material adverse effect on the Company’s consolidated results of operations, financial position or liquidity.”

 

 

Warranty:  Looking at CAT’s warranty accruals, it looks like a slight benefit year-on-year.  This is partly a product of lower sales, and is offset by higher stock compensation in the 1Q15 results.  

 

CAT: Cat Financial & 10-Q Review - po4

 

 

Upshot:  While we think CAT may be able to post a favorable 2Q15, we expect significant pain later in 2015.  By year-end, we see annualized EPS below 2016 estimates, mounting credit losses in the resources-exposed Cat Financial portfolio (mining, coal, oil & gas, etc), and renewed pressure on management/controls... perhaps (finally) precipitating a bottom in CAT's relative performance.  


European Banking Monitor: Outside of Greece, Financials Swaps Mostly Tighter

Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor".  If you'd like to receive the work of the Financials team or request a trial please email 

 

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European Financial CDS - Swaps mostly tightened in Europe last week. However, as has become commonplace, another week went by without a deal on Greece’s bailout, and CDS spreads in the country rose in excess of 100 bps.

 

European Banking Monitor: Outside of Greece, Financials Swaps Mostly Tighter - chart1 financials CDS

 

Sovereign CDS – Sovereign Swaps were little changed last week. The median spread held constant at 43 bps. However, Italian, Spanish, and Portuguese swaps did tighten in a partial recovery from the previous week. The swaps tightened by 7 bps to 125, 7 bps to 93, and 12 bps to 149, respectively.

 

European Banking Monitor: Outside of Greece, Financials Swaps Mostly Tighter - chart2 sovereign CDS

 

European Banking Monitor: Outside of Greece, Financials Swaps Mostly Tighter - chart3 sovereign CDS

 

European Banking Monitor: Outside of Greece, Financials Swaps Mostly Tighter - chart4 sovereign CDS

 

Euribor-OIS Spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread was unchanged at 10 bps.

 

European Banking Monitor: Outside of Greece, Financials Swaps Mostly Tighter - chart5 euribor OIS Spread

 

 

Matthew Hedrick

Associate

 

Ben Ryan

Analyst

 

 

 


Keith's Macro Notebook 5/4: China | Europe | 10YR Yields

 

Hedgeye CEO Keith McCullough shares the top three things in his macro notebook this morning.


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Call Invite | General Mills Black Book (GIS) – The GIS (Activist)Playbook for the next 12-18 months.

Takeaway: We have a positive bias to GIS and will be adding it to the Hedgeye Best Ideas list as a LONG.

On Wednesday, May 6th at 11:00am EST we will be hosting a Black Book conference call on General Mills. Dial-in details and associated materials to follow.

 

We have a positive bias to GIS and will be adding it to the Hedgeye Best Ideas list as a LONG.  The call will be a detail look at the company and what can be done to improve the overall performance of the company.

 

We break down the 90 page presentation into three key points:

 

GIS NEEDS TO BE REINVENTED!

The opportunity to create significant shareholder value from repositioning the company is significant. The recent performance suggests that management may be too stuck in the past to reshape the company in a way that will accelerate top line growth. There have been a number of events over the past few years that suggest the timing is optimal for an activist to come on and re-shape management and the board.

 

MANY WAYS TO WIN

GIS has done a lot of things to stave off an activist attack, but it will all be for nothing if they do not execute on their growth plan. GIS is a great company with strong brands, but its business practices and backward looking are insular. Reshaping the portfolio of brands, CPW and G&A cuts are just some of the ways to create significant shareholder value.

 

TRANSFORMATIONAL TRANSACTION

GIS needs to reshape the company to stay as a premier global food company. Alternatively, GIS would make a solid acquisition target, especially for a large consumer snack food company. GIS needs to accelerate its growth and management is struggling to do it internally.  In our view, selling the company would be an ideal scenario for all stakeholders. Or reinvent the company through meaningful acquisitions and divestitures.

 

SUMMARY

We are cognizant of the fact that GIS is trading at a premium valuation and speculation is rampant that the company may be in play.  We agree the company is in play and it's just a matter of time before the intrinsic value of the company is realized. 

 

The call will last about an hour including time for Q&A.


Call Invite | Thought Leader Roundtable – A detailed look at the Cereal Industry

On May 5th at 11:00am EST we will be hosting a conference call on the Cereal industry with David Sprinkle.  David is the research director at Packaged Facts, which publishes a leading line of syndicated research reports on the U.S. food market.

 

Topics will include:

  • The future of the both the cold and hot segments
  • The split personality of the segment
  • Pricing trends
  • The ancient grain story
  • Where the category is struggling
  • Where the categories winners are
  • Why the category is important
  • What breakfast categories are growing/emerging

This call be will be followed by a detailed Black Book on General Mills on May 6th at 11:00am EST. 

 

David Sprinkle is the research director at Packaged Facts, which publishes a leading line of syndicated research reports on the U.S. food market.  He has contributed to publications such as Candy & Snack Today, Gourmet Retailer, Natural Products Insider, Nutraceuticals World, and Progressive Grocer, as well as  presented at industry conferences including Engredia, Fancy Food Show, GOED Exchange, Global Food Forums, Global Forum on the Future of Food, Healthy Beverages Expo, Ingredient MarketPlace, Institute of Food Technologists (IFT), IFT Wellness, International Baking Industry Expo, National Coffee Association, National Confectioners Association, Nutracon, SupplySide West, and World Tea Expo.  Book-length publications through Packaged Facts include Premium Consumers and the New Economy and Americans in 2020.  David has an MBA from Tulane University in New Orleans, where he also taught business communications.

 

The call will last about an hour including time for Q&A.

 

Dial-in details and associated materials to follow.


Monday Mashup

Monday Mashup - 1

 

Recent Notes

04/27/15 Monday Mashup

04/27/15 PNRA: Thoughts into the Print (1Q15)

04/28/15 DFRG: Short on Strength

04/29/15 PNRA: Unconvincing, But That’s Okay

04/30/15 Casual Dining Shorts?

05/01/15 YUM: Attracting the Attention it Deserves


Events This Week

Monday, May 4

  • MCD Turnaround Plan 11:00am EST
  • BBRG earnings call 4:30pm EST
  • CHUY earnings call 4:30pm EST
  • DENN earnings call 4:30pm EST
  • IRG earnings call 4:30pm EST
  • TXRH earnings call 5:00pm EST

Tuesday, May 5

  • TAST earnings call 8:30am EST
  • BLMN earnings call 9:00am EST
  • NDLS earnings call 4:30pm EST
  • KONA earnings call 5:00pm EST
  • PBPB earnings call 5:00pm EST
  • BBRG annual general meeting
  • DAVE annual general meeting
  • Robert W. Baird Growth Stock Conference: HABT, ZOES, CMG, BWLD, DNKN, IRG, KKD

Wednesday, May 6

  • DAVE earnings call 8:00am EST
  • WEN earnings call 9:00am EST
  • PZZA earnings call 10:00am EST
  • FRSH earnings call 5:00pm EST
  • NDLS annual general meeting
  • Robert W. Bair Growth Stock Conference: CHUY, PBPB

Thursday, May 7

  • BAGR earnings call 4:30pm EST
  • JMBA earnings call 5:00pm EST
  • BWLD annual general meeting

 

Recent News Flow

Monday, April 27

  • CMG became the first national restaurant company to use only non-GMO ingredients.
  • WEN appointed Kurt Kane to the newly created position of Chief Concept Officer.  Mr. Kane, who most recently served as Global Chief Marketing and Food Innovation Officer at Pizza Hut, will be responsible for all of North America marketing and innovation efforts. 

Tuesday, April 28

  • JMBA announced the sale of 21 stores to existing franchise partners as its refranchising effort continues to accelerate well ahead of schedule.  JMBA is on track to close Phase II of its refranchising efforts by the end of the calendar year, with the ultimate goal of moving the franchise to company model to 90/10%.

Wednesday, April 29

  • BOBE announced the pending closure of 20 underperforming restaurants over the next 12 months.  The company estimates net proceeds will range between $15-17 million and estimate the sale will result in a $2.5-3.5 million annual improvement in operating income.  It will incur $4.7-5.2 million of pre-tax charges related to the sale primarily during 4QF15, approximately $2.1 million of which is expected to be non-cash.
  • PZZA announced a quarterly dividend of $0.14 payable on May 22, 2015 to shareholders of record on May 11, 2015.

Thursday, April 30

  • DIN appointed Darren Rebelez as president of IHOP.  Mr. Rebelez most recently served as COO of 7-Eleven.
  • WEN is teaming up with Honest Tea to bring certified organic green tea to its restaurants nationwide.

Friday, May 1

  • CMG upgraded to outperform at BMO Capital with a $760 PT.
  • YUM Third Point announces a significant stake in YUM.
  • PBPB promoted Julie Younglove-Webb to Senior VP of Operations.  Ms. Younglove-Webb joined Potbelly back in 2008 as a General Manager and most recently served as Central Zone Vice President, a role in which she oversaw 250 shops.
  • PZZA announced that Mr. Philip Guariscio did not stand for re-election to the Company’s Board of Directors at the 2015 Annual Meeting given he had reached the age of retirement.

 

Commodities

Monday Mashup - 2

 

Sector Performance

The SPX (-0.44%) outperformed the XLY (-1.65%) last week.  Casual dining stocks, in aggregate, underperformed the XLY, while quick service stocks outperformed.

Monday Mashup - 3

Monday Mashup - 4

 

Quantitative Setup

From a quantitative perspective, the XLY remains bullish on an intermediate-term TREND duration.

Monday Mashup - 5

 

Casual Dining Restaurants

Monday Mashup - 6

Monday Mashup - 7

Quick Service Restaurants

Monday Mashup - 8

Monday Mashup - 9


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