Hedgeye CEO Keith McCullough weighs in with his unvarnished take on Apple’s third-quarter results and shares his cautious outlook for the stock and overall market with Maria Bartiromo on Fox Business.
Editor's Note: The chart and excerpt below are from today's Early Look written by Hedgye Director of Research Daryl Jones. Click here for more info on subscribing.
...Our Sector Heads by and large currently have negative fundamental biases towards the sectors and companies they cover. This, when combined with our macro view, continues to make us cautious (at best) about equity market returns in the near future.
“Be more concerned with your character than your reputation, because your character is what you really are, while your reputation is merely what others think you are.”
I picked up a copy of New York Times columnist David Brooks’ new book, “The Road to Character,” while on vacation last week. In it, Brooks discusses the obvious human bias towards being self-centered. In today's digital day and age, this is probably best personified by the #Selfie. The idea of taking your own picture has become so prevalent that U.S. Senator Cory Booker is apparently on a quest to take #selfies with every other member of the Senate.
Brooks himself admits that he is “paid to be a narcissistic blow hard.” He makes his point in the context of society over the last couple decades, which by some quantifiable measures has become 30% more narcissistic. Even more interesting (alarming?) is the growing desire among many to be famous.
According to Brooks:
“In a survey in 1976, people ranked being famous 15th out of 16 possible life goals. By 2007, 51% of young people said it was one of their principal ambitions. On a recent multiple-choice quiz, nearly twice as many middle-school girls said they would rather be a celebrity’s personal assistant than the president of Harvard University.”
Those are some pretty eye-opening trends.
Clearly, we are all guilty at times of too much self-focus and not enough selflessness. Hedgeye as a group is no exception. Yesterday, though, we suspended the self-focus and took a half day off to raise money in our second annual Hedgeye Cares Charity Golf Challenge and had a very selfless partner in The Lincoln Motor Company.
In recognition of The Lincoln Motor Company’s very generous support as title sponsor of the tournament for a second straight year, I found myself watching some of Lincoln’s commercials on YouTube and latched on to McConaughey’s quote below. (Watch the video here)
“It’s not about hugging trees, it’s not about being wasteful either, you just got to find that balance. Where taking care of yourself, takes care of more than just yourself – that’s the sweet spot.”
The quote just about nails the balance that we all strive for, but sometimes do not achieve in the age of the ubiquitous #Selfie.
I’d also like to call out the top corporate sponsorships we received from both Salesforce.com and Bloomberg. They came in big for a second straight year. In addition, many individuals like you were kind enough to lend a helping hand by either buying a foursome, donating outright, or providing items for our silent auction.
A deep thank you from all of us for your support!
We invite our Early Look readers to experience www.lincoln.com today and contact the Lincoln Concierge to find out about the new Lincoln Black Label line of vehicles and schedule a test drive. Additionally you can follow Lincoln on Facebook, Twitter and Instagram @LincolnMotorCo.
Back to the Global Macro Grind...
Inasmuch as I'm critiquing blowhards this morning, in part, it is our job at Hedgeye to broadcast and communicate our investment ideas. Accordingly, I wanted to highlight some notable commentary from a few of our Sector Heads over the last few weeks:
On 7/21, our restaurant and consumer staples guru Howard Penney added Starbucks $SBUX to his short idea bench. He wrote the following:
“SBUX obviously has significant growth potential, and has had industry leading innovation as of late. But we are growing increasingly concerned by the valuation of the stock, which trades at nearly 2 standard deviations above the five year average EV/NTM EBITDA of 12.9x. The current valuation more than adequately reflects the company’s long-term growth potential. That being said, we do have some reservations about the current growth strategy.”
Earlier this month, our healthcare team led by Tom Tobin presented a new best idea short of Computer Programs and Systems $CPSI. According to Tobin:
“CPSI’s market is saturated with 94% of all hospital having an EMR. It holds 35% market share in its core markets of <100 bed hospitals and is 56% penetrated into independent hospitals of the same bed size cohort. CPSI is selling into a shrinking market and to a financially strapped customer. Virtually all of the remaining upside is already baked into the stock. With severe underinvestment in growth (essentially zero R&D vs. peers at ~10% of sales), we’re modeling sales and cash flow contraction going forward suggesting an unsustainably high dividend (~4.6%). We see -35%-50% downside from here.”
Finally, ahead of the Las Vegas Sands (LVS) quarter tonight, our Gaming Sector Head Todd Jordan had this to say yesterday:
“For the first time in many quarters, for any Macau operator, we’re actually in line with Street EBITDA estimates for a quarter. That’s the good news. Lucky play on the Macau VIP tables could be a $30m contributor to EBITDA (3%) and is probably the reason we’re in line. Not exactly bullish but it may be good enough. We’re actually not sure how the stock will react to Wednesday’s Q2 earnings release. However, we believe estimates are ultimately headed materially lower owing to declining [high margin] base mass, falling market share (already happening in July), too optimistic non-gaming expectations and a full valuation.”
In conclusion, while it may seem like I’m now being a bit of a blowhard in emphasizing these recent calls by our research team, the key point I want to make is that the three highlights above are not just highlights, they are indicative of a trend.
Our Sector Heads by and large currently have negative fundamental biases towards the sectors and companies they cover. This, when combined with our macro view, continues to make us cautious (at best) about equity market returns in the near future.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.22-2.45%
Oil (WTI) 49.09-51.86
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
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Takeaway: The core investment thesis is on track. EPS growth is accelerating which we think gets us a $40 stock in a year.
We have WWW on our Best Ideas list as a Long, and yesterday’s print played into our view. The company beat our estimate by $0.03, which was already 20% ahead of consensus. All that said, let’s not gloss over the fact that the growth algorithm (sales +2.7%, EBIT -6.7%, EPS -14.2%) was closer to ‘awful’ than ‘decent’. Not what we expect from this company longer-term. But that rate of change is why we think it's an interesting idea. As EPS growth goes from negative to 20%+, we think we'll be looking at 20x next year's $2.00, or $40 in 9-12 months (40% upside in a year) -- and then $48 a year later.
The good news is that we’re seeing everything we need to support our thesis that EPS growth will accelerate meaningfully – effective immediately. This is in large part driven by better top line performance. One of the drivers is Merrell, which accounts for about 20% of the company, and only comped flat then up low single digits over the past two quarters. WWW changed up what had (unbeknownst to us) been toxic leadership inside the company. The fix should become apparent in numbers within two-quarters.
The International Story is On Track
But the bigger thing we like is the trajectory of the international agreements signed by WWW to sell PLG brands overseas, keeping in mind that only 5% of PLG sold overseas before the acquisition. People don’t give the company credit for this given that they don’t see the impact all at once. But the reality is that these agreements are cumulative in nature. Once a deal is signed, it takes a quarter or two to get set up with systems. Then the distributor markets product, which takes 1-2 quarters to build a book. Then the product needs to be manufactured, shipped, and received. That’s a 6-9 month process. Then, and only then, does WWW start to see revenue.
The point is that it could take upwards of 1.5-2 years from the time a deal is signed to actually show up as revenue. The company started to sign these in earnest around 1Q13. That means that the first of the deals – nevermind the subsequent 79 – just hit the top line in a meaningful way earlier this year. We don’t think this is appropriately baked into guidance.
Aside from top-line, the area where we’re different from consensus is likely on the interest expense line. Given the cash flow characteristics, we have interest expense going to zero in four years – that’s about $0.30 per share off a $1.65 base this year. Pretty meaningful from where we sit.
One caveat is that WWW is highly likely to do another deal, and lever back up again while it scales the new brand over its infrastructure. We ordinarily don’t like deals. But the fact of the matter is that WWW is good at them, and has added meaningful value and steered shareholder capital in the right direction with almost every deal its ever done. To be clear, we don’t need a deal to make this stock work. In all likelihood it works with or without a transaction.
Client Talking Points
Has a chicken scratch down-day yesterday and is back up vs $1.09 EUR this morning – this is very deflationary, but anyone positioned for that from JUL (last year) to JAN (this year) knows that; bearish for multi-national revenue/eps growth too.
Apple was not Google, and Industrials revenues are down 4% (earnings -8%) for Q2 reporting to-date. Most materials and energy (read: #Deflation risk) companies haven’t printed and guided to reality yet – stay tuned (and short Industrials = XLI).
Locally and globally, rates continue to make a series of lower-highs as sovereign bond market volatility calms (and dovish Fed rhetoric ramps) – long-term investors stayed with the Long Bond because they get growth/inflation slowing – people chasing charts, sold them (German 10yr = 0.76%, Swiss 10yr back to negative yield -0.01%, 10yr JGB down to 0.40%).
**The Macro Show - CLICK HERE to watch today's edition at 8:30AM ET.
|FIXED INCOME||27%||INTL CURRENCIES||11%|
Top Long Ideas
The General continues to make tough calls as they work to further streamline their manufacturing footprint as part of Project Century. Last week, announcing the closure of two plants, one in West Chicago, IL and the other in Joplin, MO, eliminating approximately 620 positions in the process. West Chicago produced cereal and dry dinner products for the U.S. Retail organization, while the Joplin facility was acquired as part of the Annie’s acquisition and produced snacks. Because of union negotiations management is expecting these actions to be fully executed by fiscal 2019. We view this as a big positive for the company as they go to a more nimble asset light model, which will save on capex and allow it to be allocated to higher growth product platforms.
According to Gaming, Lodging and Leisure Sector Head Todd Jordan, additional state gaming agencies have reported revenues for the month of June. The good news here is that Penn National Gaming remains on track to beat second quarter estimates this Tuesday July 23rd. In addition, PENN will be hosting an investor day on July 24th. We will be there and communicate any noteworthy color and developments. Bottom line? The company remains one of our favorite names on the long side and boasts the best new unit growth story in domestic gaming.
After an awful retail sales print on Tuesday, the confluence of growth slowing data reared its ugly head Friday with a +0.1% year-over-year headline CPI print for June and a UofMich consumer sentiment reading that declined to 93.3 from 96.1 in May. Note that a +0.1% inflation rate is a heck of a long way from the Fed’s 2% target. These two prints were successful in taking the 10-Year Treasury yield down 10 basis points from Monday’s highs to finish the week at 2.35%. We remain one of the lonely bulls on Treasury bonds (bearish on yields) via TLT, EDV, VNQ.
Three for the Road
TWEET OF THE DAY
VIDEO (2mins): Gold vs. Central Bankers? https://app.hedgeye.com/insights/45332-mccullough-gold-vs-central-bankers … $GLD@KeithMcCullough
QUOTE OF THE DAY
The significant problems we face cannot be solved at the same level of thinking we were at when we created them.
STAT OF THE DAY
In more than 135 years of global temperature data, four of the five hottest months on record all happened in 2015: February, March, May, and now June.
Daily Trading Ranges
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