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Investing Ideas - Levels

Please see below Hedgeye CEO Keith McCullough's refreshed levels for our high-conviction investing ideas.

Investing Ideas - Levels - levs 44

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

Anything longer than 3 years is unpredictable.


Investing Ideas Newsletter

Takeaway: Current Investing Ideas: VNQ, EDV, ITB, TLT, MUB & HIBB

HIBB

We added Hibbett Sports to Investing Ideas as a short this week. Retail analyst Alec Richards explains the rationale below. 

A NOTE FROM THE EDITOR

 

In light of our increasing caution towards equities and the removal of many of our favorite names, last week we featured one of our analysts' favorite short ideas, Royal Caribbean. We received an overwhelmingly positive response from Investing Idea subscribers. The common refrain we heard was, "What took you so long?!"

 

To that end, this weekend we have chosen to showcase another stock we believe is massively overpriced. In fact, our Restaurants analyst Howard Penney says this company is 'egregiously valued' and poised to drop over 50% from its current sky-high perch. 

 

Happy hunting out there on the long and short side.

 

Have a great weekend!

 

CARTOON OF THE WEEK

Investing Ideas Newsletter      - Deflation cartoon 05.12.2015

 

Below are Hedgeye analysts’ latest updates on our five current high-conviction long investing ideas, one short idea, and an additional new short idea from our Restaurants team.

 

We will send CEO Keith McCullough’s updated levels for each in a separate email. 

 

We added Hibbett Sports (HIBB) this week.

 

As always, we also feature two additional pieces of content at the bottom. 

SPOTLIGHT: BEST IDEA SHORT

For the most part, the Shake Shack (SHAK) growth story (business model) is predicated on the view that what works well in New York City will work well in the rest of the world. In our view, when it comes to operating a small cap growth restaurant company, NYC is not the center of the universe. Just ask the management team at DFRG.

 

Investing Ideas Newsletter      - zen

 

The bull case for the stock centers on the brand’s unique beginnings and its “cult-like” status, which sets it apart from other better-burger operators. The company has guided the street to sustained, long-term EBITDA growth of +20%. This growth is expected to be driven by +20% domestic unit growth, execution on existing agreements for overseas licensed growth, low single digit SSS, and modest operating leverage.

 

The stock is reflecting a performance that assumes multiples of the aforementioned guidance. What the stock is not reflecting is the inevitable reality that, at the end of the day, it is just a restaurant company and the “cult-like” status will not last forever. We’ve seen many “cult-like” companies come and go and the vast majority of these stories have ended poorly.

 

To simplify the SHAK story, the only thing that will truly matter from here on out is the performance of new units.

 

There are currently 63 Shake Shacks worldwide, with about 49% of the store base company-owned. Most of the franchised stores are operated internationally, the majority of which are in the Middle East. Going forward, management is targeting at least ten company openings a year, and wants to triple its domestic footprint over the next five years. This translates to +32% and +27% domestic growth in 2015 and 2016, respectively. This would put SHAK’s growth rate at the highest in the industry and significantly above the more mature fast casual players that are growing in the +8-14% range.

 

Despite only having 63 units, management believes that Shake Shack “has become a beloved global brand with a power reaching multiples beyond [its] size.” Ah, a classic New Yorker’s view of the world. During the 4Q14 earnings call, CEO Randall Garutti went on to say, “The excitement we create during our openings and the ongoing connection we have with our fans through an intensive social media strategy, graphic design, and unique collaborations have together powered our voice and created a truly dynamic connection with our loyal Shack fans.”

 

Remember, Shake Shack is in the nascent stage of growth with a business model that is largely based on how New Yorkers view the brand. With 63 units, and only 13 in the same-store sales base (new units take 24 months to enter the base), management believes it has covered all of the bases. Its “versatile real estate model is built for growth, already proven throughout the country in varied formats: in urban, suburban, mall, train stations, airports, and even ballparks.” With roughly half of its units in the US, it’s difficult to imagine that management believes they have it all figured out. The runway for growth can be a lot smaller than most imagine and there is significant room for operational risk along the way.

 

Bottom line: SHAK shares are egregiously overvalued and could fall over 50%, perhaps even more.

IDEAS UPDATES

HIBB

We added Hibbett Sports to Investing Ideas as a short this week. Retail analyst Alec Richards explains the rationale above.

 

We think that HIBB is one of the most structurally challenged retailers in all of retail.

 

The company grew up to 1,000 retail stores mainly in the Southeastern United states with most of its doors within spitting distance of Walmart. The strategy was simple, 1) leverage WMT traffic, and 2) sell higher ticket sporting goods, footwear, and apparel from national brands that one cannot find at a WMT. But, now growth is tapped in its core market (over 95% of WMT’s in the company’s home state of Alabama have a HIBB within 5 miles) and must look to new markets like PA and the Southwestern United States for growth.

 

The problem is that a) HIBB has no brand equity in these markets, b) an underdeveloped distribution network making it impossible to service these markets in a cost effective manner, c) now has to compete in markets with an existing competitive presence (Dick’s Sporting Goods, Academy + Outdoor, Sports Authority) and d) manage competition entering its core market.

 

Add to that the fact that WMT – the retailer HIBB is most dependent on as a traffic driver – has posted negative traffic metrics in 8 of the past 9 quarters as it looks to e-commerce for its next leg of growth. The only problem is that HIBB can’t put a store next to WMT online, and it is one of the only retailers today that still does not have an e-commerce operation. That development of e-commerce capabilities appears to be in the works, but based on what we’ve seen from other retailers building out e-comm capabilities it could mean 300-500bps of margin headwind as the cost investment needed to enter the online marketplace, that has been driving outsized growth, flows through the P&L.

 

Ultimately we see top line trends decelerating, costs accelerating, and capital requirements are going nowhere but up. Any form of growth from here on out – in existing stores, new stores, and online, will all come at a lower margin. This year will be a roller coaster (mostly down) but we think next year’s earnings miss becomes explosive. HIBB is one of our top short ideas.

ITB

The ITB turned in modest positive absolute and relative performance in the latest week as the advance in interest rates ebbed and the high frequency mortgage purchase application data continued to reflect improving housing demand trends. 

 

Purchase activity was flat week-over-week but held at 23-month highs with demand growing +11.7% on a year-over-year basis.  As it stands, 2Q15 is currently running +14.5 QoQ, +13.7% YoY, and on track for its best quarter in two years.  

 

The Mortgage Bankers Association also released its Mortgage Credit Availability Index (MCAI) for April on Tuesday.  The MCAI made a new cycle high, increasing +0.5% month-over-month with the Government and Jumbo indices leading the gains.  The regulatory pendulum continues to swing towards credit box expansion in 2015 and should provide marginal support to transaction volumes, particularly for prospective entry level buyers.

 

Next week will offer a more comprehensive update on the state of activity in both the New and Existing markets with the NAHB’s Builder Confidence Survey (May Data), Housing Starts (April Data), and Existing Home Sales (April data) slated for release on Monday, Tuesday & Thursday, respectively.  

 

Click to enlarge.

Investing Ideas Newsletter      - z Compendium 051315

VNQ | TLT | MUB | EDV 

 

In last week’s newsletter, we asked the question as to whether or not interest rates can move lower in both a deflationary and inflationary environment:

 

“While history suggests long-duration fixed income works in a QUAD3 scenario which we are moving closer to hitting in Q2, the performance hasn’t been as strong as a QUAD 4 set-up. However if the debate is between QUAD4 and QUAD3, bonds work in both scenarios.”


The counter-TREND moves in the USD and commodities have been extensive and now confirmed:

  • U.S. Dollar: Down another 1.20% w/w to complete its BULLISH to BEARISH TREND Reversal. The dollar is now BULLISH on a TAIL duration (three years or less) and BEARISH on a TREND duration (3-Months or more)
  • CRB Index: +2.0% w/w and +5.5% 1-Month Change. The CRB is now BULLISH on a TREND duration and BEARISH on a TAIL duration

As Keith wrote in Friday’s Early Look newsletter , the longer-term sequence events causing the respective TAIL lines in the USD and Commodities to continue is as follows:

  1. “Currency War (centrally planned FX devaluations to create growth and inflation) will see Japan, Europe, and the USA fail
  2. As each of the 3 majors sees growth and/or inflation slowing, they’ll take their turn with more of what has not worked
  3. In the end, the US has the best demographics of the 3, so they’ll have the best real growth of the 3 (and strongest currency)”

The move in 10-Year treasury yields on Wednesday’s retail sales miss was a good exercise in markets front-running central-planning:

  • Retail Sales printed a goose egg (0%) sequentially in April
  • On a y/y basis retail sales printed a measly +0.9%, which is a major slowdown from the 4-5% growth rates back in the fall of 2014

Investing Ideas Newsletter      - z ben Retail Sales

 

  • The USD got whacked for a -1% day Wednesday (-1% on the week and -5.8% over the last month)
  • The U.S. 10-Year Yield which was pulled-up from the big move higher in European sovereign yields Wednesday, reverted 10bps from the End-of-Day highs on Wednesday to finish the week +4bps higher (2.19%).

The reality is that we are in a #LateCycle slowdown and the jockeying around each incremental data point will continue to get more and more intense as the Fed’s only ammo for suspending the cycle that has unfolded many times over is to push out the dots on a rate hike. #LowerForLonger.

 

* * * * * * * * * * 

ADDITIONAL RESEARCH CONTENT BELOW

ici fund flow survey: skittish

Both active and passive domestic products had redemptions in the latest week notes Hedgeye Financials analyst Jonathan Casteleyn..

Investing Ideas Newsletter      - Sheepish bull cartoon 05.05.2015

YELP: Mayday!

"Just because YELP may be for sale doesn't mean there would be buyer," writes Internet & Media analyst Hesham Shaaban. "All it means is that mgmt is terrified...maybe they finally get it."

Investing Ideas Newsletter      - Yelp cartoon 02.06.2015


The Week Ahead

The Economic Data calendar for the week of the 18th of May through the 22nd of May is full of critical releases and events.  Here is a snapshot of some of the headline numbers that we will be focused on.

CLICK TO ENLARGE.

The Week Ahead - z week ahead


investing ideas

Risk Managed Long Term Investing for Pros

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.


Avian Flu ― Higher Grocery Bills for Consumers and Higher Input Costs for Producers

Takeaway: Currently estimated that more than 30 million birds have been euthanized because of AI.

This is an unprecedented outbreak that U.S. farmers have never had to deal with, it is currently estimated that more than 30 million birds have been euthanized because of AI.

 

Recent Events:

Thursday, May 14th, Post Holdings announced that roughly 25% of the company’s egg supply has been affected after the most recent AI outbreak in company owned chickens in Nebraska. Just three days ago on Tuesday they announced the flu had affected 20% of their supply. When they announced the 20% it was estimated it would be a $20 million hit, they are working on updating this estimate now.

 

Tuesday, May 12th, agriculture officials confirmed that the outbreak has been spread to Nebraska, making it the 16th state with confirmed cases of the virus.

 

May 1st, Iowa Governor Terry Branstad declared a state of emergency due to the outbreak in his state.

 

Into the Note:

It is widely accepted that the Avian Flu virus poses no threat to humans, but every chicken or turkey that is infected must be destroyed in order to preserve the health of the poultry population. We are beginning to see an impact on prices and availability at the grocery store. Dr. Dermot Hayes, an agricultural economist at Iowa state explained that, “…for every million birds we lose, we’ll see about a 1.6% price increase…We’re looking at between a 20-30% increase in retail prices.” With these rise in prices it’s not just the cartons of eggs that will be affected, there are many products like mayonnaise and ice cream that use eggs as an ingredient.

 

What does this mean for the rest of the breakfast category?

Per our recent discussion with David Sprinkle at Packaged Facts, eggs hold the number 1 household usage rates for breakfast in the United States, as seen in the chart below.

 

Avian Flu ― Higher Grocery Bills for Consumers and Higher Input Costs for Producers - Avian Flu Chart 1

 

With these rising prices soon to be seen across the country, we do not believe usage will stay this high.  Average price for a dozen eggs in March 2015 was $2.13 per dozen (BLS), while a box of Cheerios on Amazon Fresh are $2.99 and Milk is $3.46/gl (BLS).  As the price of eggs begins to creep up, we believe that it won’t be a default choice for consumers to pick up a dozen eggs as their go to choice for breakfast.

 

GIS, K, POST

We expect to see slight benefit going forward in the cereal category as consumers rethink their breakfast choice and go back to the classic bowl of cereal. But the bigger problem we see is the hit this will be to POST’s earnings. POST’s Michael Foods division a processor and distributor of mainly egg products representing ~28% of POST net sales, will undoubtedly be an area of concern for management. POST management recently stated, “Michael Foods is taking various measures including discontinuation of certain product lines and appropriate pricing actions to offset reduced egg supply and increased operating costs.” This spells trouble for earnings going forward and there is no telling yet just how deep the impact will be.

 


GIS – THE TRANSFORMATIONAL TRANSACTION

Takeaway: One way an activist can transform this portfolio is to do a Reverse Morris Trust (RMT)

GIS is on the HEDGEYE Best Ideas list as a LONG!

 

GIS is a great company with strong brands. 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.

 

We view GIS as an attractive target for an activist and that 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.  As it stands today, given the current portfolio of brands, it’s unlikely that management will be able to accelerate top line growth without making significant changes to the company. 

 

As we outlined in our Black Book on GIS, we continue to believe that the opportunity to create significant shareholder value from repositioning the company is significant.  A key tenant to the value creation strategy is a re-shaping of the company’s portfolio, which means selling the brands that management has determined as non-core brands.   

 

GIS has been rumored to sell off a number of brands, but doing it one by one is inefficient and not tax effective.  We calculate that management has identified roughly $5 billion in sales that are non-core brands that could potentially be sold.

 

One way an activist can present this possibility is to do a Reverse Morris Trust (RMT) with some of the brands.  All of the brands that we have identified as non-core can fit nicely in a separate company.

 

The idea is to spin the slow growing low margin businesses into an RMT, leaving the NEW GIS as a company focused on the fast growing parts of the food business – yogurt, snacks and food service.  It will also allow the company to focus on reinventing the core cereal business.

 

Below is a look into what an RMT is, precedent transactions using this method and a couple diagrams for a visual.

 

GIS – THE TRANSFORMATIONAL TRANSACTION - RMT Chart 1

 

GIS – THE TRANSFORMATIONAL TRANSACTION - RMT Chart 2

 

GIS – THE TRANSFORMATIONAL TRANSACTION - RMT Chart 3

 

GIS – THE TRANSFORMATIONAL TRANSACTION - RMT CHART 4

 

Let us know if you have any questions, or would like to discuss in more detail who GIS could partner with in a RMT.

 

Howard Penney

@HedgeyeHWP

 


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