Hedgeye's Internet & Media Sector Head Hesham Shaabban stopped The Macro Show last week to discuss some of the key structural headwinds currently facing Twitter.
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Editor's Note: This comes from a research note Hedgeye CEO Keith McCullough sent to subscribers Friday. If you're serious about stepping up your market game we encourage you to take a look at our offerings.
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While the macro narrative on why bond yields rallied to lower-long-term highs (again) remains malleable, the data is not.
When strategists tell you “inflation is breaking out – so bond yields are going higher,” send them these 3 charts. To be clear, bottoms are processes, not points. And all we’re seeing is a reflation of one mother of a #deflation risk.
If the Fed makes a mistake and raises rates (Dollar Up, Commodities Smoked), they’ll perpetuate #deflation and a corporate profit slow-down in #LateCycle sectors that have already lost pricing power.
- 1st chart = Headline and Core YoY
- 2nd chart = Goods vs Services, YoY
- 3rd Chart = Energy – MoM & YoY
Click to enlarge
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Takeaway: The first 5 months of 2015 for domestic equity mutual funds have had the worst start to any annual period since 2012 (and worst than 2008).
This note was originally published June 11, 2015 at 11:50 in Financials. For more information on our various products and how you can subscribe click here.
Investment Company Institute Mutual Fund Data and ETF Money Flow:
Equity ETF flows and taxable bond mutual fund flows were strong last week at +$7.3 billion and +$2.0 billion respectively. Meanwhile, domestic equity and tax-free bond funds continued their losing streaks, although munis were basically flat at just a -$2 million redemption (although now totaling 5 straight weeks of outflows). Domestic equity mutual funds however continue to be the biggest loser in weekly surveys with another -$4.2 billion taken back by investors during the most recent 5 days. As depicted in the chart below, the asset class has now lost a total of -$45.7 billion in the first 23 weeks of 2015, the weakest start to a year since 2012 (and a worst start than 2008).
Overall, demand for total equity products (mutual funds and ETFs) outweighed that for total bond as investors reacted to the recent grind higher in yields; total equity flows net of total bond flows were +$4.2 billion.
In the most recent 5-day period ending June 3rd, total equity mutual funds put up net outflows of -$882 million, trailing the year-to-date weekly average inflow of +$606 million and the 2014 average inflow of +$620 million. The outflow was composed of international stock fund contributions of +$3.3 billion and domestic stock fund withdrawals of -$4.2 billion. International equity funds have had positive flows in 48 of the last 52 weeks while domestic equity funds have had only 10 weeks of positive flows over the same time period.
Fixed income mutual funds put up net inflows of +$2.0 billion, trailing the year-to-date weekly average inflow of +$2.2 billion but outpacing the 2014 average inflow of +$929 million. The inflow was composed of tax-free or municipal bond funds withdrawals of -$2 million and taxable bond funds contributions of +$2.0 billion.
Equity ETFs had net subscriptions of +$7.3 billion, outpacing the year-to-date weekly average inflow of +$1.9 billion and the 2014 average inflow of +$3.2 billion. Fixed income ETFs had net inflows of +$245 million, trailing the year-to-date weekly average inflow of +$1.1 billion and the 2014 average inflow of +$1.0 billion.
Mutual fund flow data is collected weekly from the Investment Company Institute (ICI) and represents a survey of 95% of the investment management industry's mutual fund assets. Mutual fund data largely reflects the actions of retail investors. Exchange traded fund (ETF) information is extracted from Bloomberg and is matched to the same weekly reporting schedule as the ICI mutual fund data. According to industry leader Blackrock (BLK), U.S. ETF participation is 60% institutional investors and 40% retail investors.
Most Recent 12 Week Flow in Millions by Mutual Fund Product: Chart data is the most recent 12 weeks from the ICI mutual fund survey and includes the weekly average for 2014 and the weekly year-to-date average for 2015:
Cumulative Annual Flow in Millions by Mutual Fund Product: Chart data is the cumulative fund flow from the ICI mutual fund survey for each year starting with 2008.
Most Recent 12 Week Flow within Equity and Fixed Income Exchange Traded Funds: Chart data is the most recent 12 weeks from Bloomberg's ETF database (matched to the Wednesday to Wednesday reporting format of the ICI), the weekly average for 2014, and the weekly year-to-date average for 2015. In the third table are the results of the weekly flows into and out of the major market and sector SPDRs:
Sector and Asset Class Weekly ETF and Year-to-Date Results: In sector SPDR callouts, the long treasury TLT continued to bleed funds. It lost another -$314 million or -7% in net withdrawals last week.
Cumulative Annual Flow in Millions within Equity and Fixed Income Exchange Traded Funds: Chart data is the cumulative fund flow from Bloomberg's ETF database for each year starting with 2013.
The net of total equity mutual fund and ETF flows against total bond mutual fund and ETF flows totaled a positive +$4.2 billion spread for the week (+$6.4 billion of total equity inflow net of the +$2.3 billion inflow to fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52-week moving average is +$1.5 billion (more positive money flow to equities) with a 52-week high of +$27.9 billion (more positive money flow to equities) and a 52-week low of -$13.1 billion (negative numbers imply more positive money flow to bonds for the week.)
Exposures: The weekly data herein is important for the public asset managers with trends in mutual funds and ETFs impacting the companies with the following estimated revenue impact:
Jonathan Casteleyn, CFA, CMT
Joshua Steiner, CFA
Client Talking Points
To get things like Oil prices and PPI (producer prices) up year-over-year, what the Fed actually needs to do is devalue the Dollar and start talking up no-rate-hike. In other words, the bull case for stocks, commodities, and bonds is #SlowerForLonger. The U.S. Dollar Index was down -1.4% last week (down -4.5% in the last 3 months), the immediate-term risk range is 94.01-95.98.
The CRB index is up +0.4% week-over-week (+4.1% in the last 3 months). We generally regard changes in commodity prices on the margin as having meaningful consumption implications. WTI Oil was up +1.4% week-over-week (+14.7% in the last 3 months) and Gold was up +1.0% week-over-week (+2.2% in the last 3 months).
Same-restaurant sales retracted to +1.1% and same-restaurant traffic decreased -2.3% both down 80 basis points sequentially. Traditionally, strong employment trends would suggest a healthy sales environment for restaurant operators. There continues to be a clear divergence between improvement in the employment data and same-store sales and traffic trends for the industry.
|FIXED INCOME||27%||INTL CURRENCIES||2%|
Top Long Ideas
Penn National Gaming will likely tee off on the bears with a strong Q2, upward 2015/2016 EPS revisions, and the start of a 2 year growth period. PENN’s stock has climbed 27% this year on stabilizing regional gaming revenues, transaction-fueled optimism (real estate) surrounding the regional gaming companies and proximity to the opening of the new Plainridge racino on June 24. So what will drive even more upside? More and better. We think regional gaming trends are even better than anticipated by the Street and Q2 earnings should be a solid beat even before Plainridge contributes.
Housing outperformed in the latest week alongside choppy price action in equities and further, extraordinary volatility in sovereign bond markets. Fundamental data was light with weekly purchase applications data from the MBA the lone release of import for the industry. The first, high-frequency update on purchase demand in June, however, was positive. Purchase demand rose +9.7% sequentially, taking the index to its strongest level in 2 years at reading of 214.3. On a year-over-year basis, growth accelerated for a 4th consecutive week to +14.6%. Inclusive of last weeks gain, demand in 2Q is tracking +14.3% QoQ and +13.4% YoY.
The market has been jockeying for positioning in front of next week’s policy statement from Janet Yellen. We believe Yellen signaling that she remains “data dependent” (i.e. repeats what she said at the March 18thmeeting) is the most probable outcome. To be clear, we remain the long-bond bulls (TLT, EDV, MUB). With that being said we aren’t claiming to be able to predict the outcome of next week’s meeting (sure we do have biases). What we do know is that Hedgeye estimates for growth and inflation shake out much lower against both consensus and central bank forecasts for the full year 2015 (remember that this is after their forecasts have already been downwardly revised).
Three for the Road
TWEET OF THE DAY
Top Private Investor Buddy Carter Talks Process, Market Volatility and Ranges with Keith McCullough https://app.hedgeye.com/insights/44663-keith-mccullough-and-top-private-investor-buddy-carter-talk-process-m… via @hedgeye
QUOTE OF THE DAY
Vision without execution is hallucination.
STAT OF THE DAY
According to a study published in the journal BMC Public Health, the average American is 33 pounds heavier than the average Frenchman, 40 pounds heavier than the average Japanese citizen, and 70 pounds heavier than the average citizen of Bangladesh.
Takeaway: The convert takes RH from net debt to net cash, and funds new concepts as well as sourcing/vendor base as the growth plan plays out.
We weren’t expecting to get hit with a press release from RH this morning about another convert offering. But it makes all the sense in the world. As we’ve stated many times, this is kind of transformative and disruptive growth story that comes along maybe once every decade in retail. But growth does not come cheap. While the company is on the cusp of being cash flow positive, the market is presenting an opportunity – with the stock 5% from its all-time high – to lock up funding for new concepts should they test well. This deal also completely wipes out RH’s net debt position. Simply put, you don’t see great retail concepts with net debt. Now you don’t see it at RH either.
While it might seem extremely similar to the convert RH executed last summer, the intent is very different. A few considerations…
- Last year’s deal, which netted RH $350mm in cash and becomes dilutive after the stock hits $172, was rather defensive. Yes, RH did it when the stock was near all-time highs (like today), but there was an interesting dynamic at play.
- Specifically, RH was starting to sign leases beyond 3Q16, which was the exact time that its credit facility expired. The bear case therefore was that RH was building bigger stores, and signing leases past the point where it had guaranteed financing. If we were to go into a recession, then the company would be on the hook for the leases without financial backing. That’s the ‘doomsday scenario’ that RH’s last deal pretty much blew out of the water.
- This time around, RH is securing the capital it might need if it chooses to expand more rapidly on concepts like RH Modern, and what’s likely another half dozen that are in the works. This is pure offense.
- To be clear, this is not just so RH could have capital to build out stores. That’s the least of our worries, actually. Landlords are bending over backwards to get RH as a tenant. Specifically, this capital gives RH the capital to ensure an appropriate build out of its sourcing organization and vendor network – which we think is critical to the company achieving it’s long-term plan.
06/11/15 10:48 PM EDT
RH - The Story Never Looked Better
Conclusion: We have never felt better about this story, and about management’s ability to profitably create growth that skeptics think does not exist.
This quarter is exactly what we were looking for from RH. The company put up a 15% comp – right in line with our model – and well above the 11% consensus. That flowed through to the bottom line with $0.23 in EPS, in line with our estimate, and 15% better than the Street.
In addition to the beat, we saw new store productivity get better on the margin, and management noted that Atlanta (about 6% of total square footage) is running ahead of expectations. Note that this had been a point of concern over the past quarter for many on the Street, as it is the first of the mega-galleries RH will be rolling out over the next few months. If Atlanta’s productivity was not cutting it, then we could see the reason for broader concern about the future. That issue is officially put to bed.
We like what the company did with guidance. It beat by $0.03, but took up the lower end of full year guidance by $0.07, and the top end by $0.05. At the same time, the company noted that there would be a meaningful ramp in 2H, and as such took down 2Q. Naturally, almost all of the questions we’ve gotten since the print revolve around 2Q guidance.
Let’s be clear about something…companies up and down the S&P and Russell are ‘conservatively’ guiding to down revenue, down margins and down earnings. With RH, not only did it take up guidance for the year – when it otherwise did not need to – but the mid-point of guidance for its worst quarter of the year calls for 15% revenue growth, improving new store productivity, and 23% earnings growth. That’s a pretty impressive algorithm in itself, especially given the fact that we start to see the benefit of new square footage growth in 2H15 as well as the impact of its new RH Modern concept.
The point here is that if the biggest thing people are worrying about is 2Q guidance, then we’ll take that any day given the fundamental setup that will likely allow RH to best its guidance while simultaneously staring at a meaningful 2H acceleration square in the face.
RH Modern: We think that most reports out this morning are likely to miss the mark on Modern. This is a lot more than a new category or concept for RH. We think it’s more like a classification. Think about it…everything that RH currently sells – whether it be Sofas, Chairs, Tables, Lighting, Flooring, Kitchen – that all falls under the traditional RH aesthetic. RH Modern, however, allows the company the opportunity to take every single category it sells, layer them over a new classification, and sell to a completely different customer.
If we have any concerns about this it will be the availability of retail space to sell the product – and the potential that RH takes space away from existing items to make room for RH Modern while it ramps up (which will take some time). Our sense, however, is that the stores will be getting bigger because the company will have the need for even more space. We’re going to follow up with another RH Black Book where we dive into the company’s real estate strategy in great detail. Expect that in the coming weeks.
Here Are Some Of Our More Detailed Thoughts From Earlier this Week
06/09/15 05:16 PM EDT
RH – ROADMAP INTO THE PRINT
Takeaway: When a Consumer story is this explosive and disruptive, every quarter is an event. Fortunately, this story is very much on track.
Our team remains convinced that RH is one of the unique TAIL opportunities in Consumer/Retail as the company disrupts a large fragmented space of localized high-cost competitors, and changes the paradigm for how people shop for Home Furnishings. This is, at most, in the second inning and the types of changes we’ll see to product classification, consumer type, purchasing experience and ensuing financial characteristics are neither in Consumers’ sights, or Wall Street’s models.
When all is said and done, we still think that this company has $11 in earnings power 4-years out, which is nearly double the consensus. We remain convinced that the debate should not be ‘if or when’ the stock hits $115 (22% upside -- the highest sell-side price target out there), but rather when we all have to adjust estimates for last year’s convert, which becomes mildly dilutive at $172 (83% upside). At that point, we’ll be looking at an earnings CAGR of 40-50% over five years. What kind of multiple does that deserve? 20x? 25x? 30x? We’d argue the higher end, but regardless, we’re talking a stock between $225 and $325. We won’t bicker which one it is with the stock at $94 today.
So there’s our TAIL call. And despite our confidence in where it’s headed long-term, we have to respect the near-term volatility in the market, and in particular, such dynamic transformational stories like RH. With all of that said, here’s a look at our key modeling assumptions for the quarter and the year, and more importantly, what can go wrong on Thursday after the close that might be a negative surprise to the market (i.e. let’s flesh it out now).
What Could Go Wrong
1. Revenue Weakness. This is the obvious item for a high multiple controversial growth stock. RH guided to revenue growth of 13-15% for the quarter. We’re at 16%. Considerations…
- Furniture sales ticked down materially industry-wide in April, though actually accelerated to the upside on a 2-year basis throughout the quarter. WSM noted this as well – but its sales accelerated on a 2yr basis by 300bps in 1Q even with the slowdown. Adding back the $30mm from the port strike sales accelerated 560bps
2. Management reset the topline bar when it issued guidance in March for FY15, and expectations look very conservative for both 1Q15 and the full year. 20% DTC growth (an almost 10 percentage point deceleration on the 2yr trend line sequentially) alone would support an 11% brand comp in the quarter, just a couple basis points shy of the current consensus numbers. The revenue backlog looked extremely positive headed out of 4Q14 with deferred revenue up 37% YY. In prior quarters deferred revenue has been a tightly correlated indicator of future growth.
3. Atlanta Opening. There has been so much negative noise around the new Atlanta Design Gallery, which opened in November. The source? None other than negative YELP reviews – all 8 of them. We actually couldn’t believe how many times we were asked about this. Maybe YELP is reliable to find a good cheeseburger for $12, but not for a $20,000 bedroom set at RH. Yes, it would be extremely negative if the company came out and said that Atlanta is a bust. But that is so highly unlikely. Think of the timing. It opened in November, then built local awareness for a few months, and did not really book any material revenue until 8-10 weeks later (i.e. March). As of 3-months ago, it had the second best opening of any store in the fleet. Things are highly unlikely to have turned so fast. So…we flag this as a risk, but it’s not a big one.
4. Backlog. The West coast port slowdown and lower inventory position (sales growth was in excess of inventory growth in 4Q14) will mitigate the flow of the product back log in 1Q, but that’s already in consensus numbers. The $10mm - $12mm revenue push from 1Q15 to 2Q15 management guided to shaves 250-300bps off the top line in the quarter the company will report of Thursday. But, that is far less exaggerated than the 500-600bps revenue hit WSM experienced. That’s because a) 95% of RH’s business is cash and carry compared to WSM at less than ~50% and b) WSM relies much more on seasonal product which is much more dependent on inventory in-stock positions.
5. New Concepts – On the call, RH should give detail on the two new concepts that it has had in the hopper for the past year (two of many, we should add). If it does NOT, however, then the Street will be left wanting. It might also cost the company revenue in 2H, as these concepts have probably started to fuel expectations. While the company didn’t officially say that it would unveil its two new lines on the 1Q call, the timing of the 2Q15 print (the company’s next officially scheduled opportunity to communicate with the street) doesn’t fall until early September. By that point it’s possible that the two source books scheduled for a Fall release will already be in homes. Thursday seems like the most logical time for the company to announce the new product coming down the pike.
6. The Biggest Loser. The Sourcebook that was just delivered weighed in at 6.5lbs, compared to 17lbs last year. That’s a huge improvement, particularly given that the Sourcebook was somewhat of a bust in 2Q14. That said, it also had twice the amount of product that we see in this year’s book. Is this the right formula? The company thinks so otherwise it would not have made the change. But the fact of the matter is that the Sourcebook remains a crutch for the company until its’ real estate profile is rightsized. Eventually, it won’t need it anymore. Until then, there will be hits and misses. Fortunately, this year we’re comping against a miss.
The Set-Up on the Top Line Improves as RH Exits 1Q.
- 2Q15 – Benefit of at least $10 - $12mm (2.5 to 3 percentage points of growth) of demand push from 1Q to 2Q due to the West Coast port delays at the same time the company laps the change up in Source Book strategy which cost the company by our math $12mm - $18mm in sales last year. RH decoupled its Outdoor Source Book (the most seasonally important book from a timing perspective) from the big Source Book mailer (which arrived in our offices yesterday) to get the category refresh in front of the consumer a month earlier than last year.
- 3Q15 – We’re modeling 3 new store openings in the quarter, 2 Full Line Design Galleries in Chicago and Denver and the re-opening of the Beverly Boulevard store in a new category/Baby & Child format after going dark when the Melrose Ave Design Gallery opened in 3Q14. That’s paired with the launch of 2 new categories. Expectations for the new lines are low as the company gains mind share, but any outperformance with the product launch could provide meaningful upside.
- 4Q15 – 2 additional Full Line Design Gallery openings in Austin and Tampa with the benefit of the new square footage added in 3Q starting to be recognized on the P&L. The 8-12 week delivery window for new product means we will begin to see the real benefit of the square footage additions in 4Q. With additional upside opportunity from the 2 new category launches.
Margins – The company guided to 100-130bps of Operating Margin expansion for the year on 14-16% revenue growth mostly attributable to ad spend leverage with ‘modest’ Gross margin expansion. There are puts and takes on both line items by quarter, but the fact that the company feels so confident in its operating margin expansion for the year, the company actually walked consensus EBIT margin expectations by 40bps on 14-16% top line growth for the year when it released guidance in February, is a bullish set-up for the year assuming the company can deliver on the top line.
Additional details on 1Q15…
- Gross Margin – We’re modeling 40bps of expansion driven by the price increases the company introduced when it released its Source Book in 2Q14. With DC occupancy pressure from the new West Coast distribution center and dead-rent for new stores opening in 2H partially offsetting the benefit. The West Coast port delays could drive additional shipping expense if product flow issues cause the company to make multiple in-home deliveries for multi-item orders.
- SG&A – The ad savings benefit will not be realized until we get into 2Q15. Because catalog costs are capitalized and then amortized over a 12 month window, the commensurate costs associated with the 2Q14 Source book will land in 1Q15. Which means marketing spend will be elevated on a YY basis. We’re modeling SG&A growth slightly below sales growth after two quarters of deleverage in part because of the absence of pre-opening related marketing expenses for new Design Galleries.
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