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Financial Engines (FNGN) | Finally the Wells Notice - Short Interest and Days to Cover Keep Us Long

Takeaway: The formal announcement of the Wells Fargo deal gets us half way to our $1.3 trillion AUC opportunity and our $55 per share fair value.

  • The company announced it has formally struck a deal to distribute its retirement services through Well Fargo

  • 2Q15 results over night were in line across the board with unchanged revenue and EBITDA guidance for the rest of the year 

  • Fee realization rates were stable pacifying the long term contention of the Bears who fear substantial pricing declines 

  • The setup in the stock is still asymmetrical to the upside with 25% of the float short and 40 days to cover 

  • FNGN remains on our Best Ideas list as a Long position with a fair value of $55 per share

 

Financial Engines (FNGN) formalized the announcement of Wells Fargo providing their independent advisory services in their 2Q15 earnings presentation last night. While the deal had been speculated by a news outlet during the course of the quarter, the formal announcement adds a solid fundamental catalyst guided to come on stream by the "middle of 2016." It is likely however that with the formal disclosure of the deal out of the way, that FNGN sales and distribution teams are already approaching the underlying plan sponsors within the Wells network and incremental assets-under-management/contract can start to bleed into the firm's numbers (after operational testing). According to the most recent Cerruli retirement survey, assets under administration at Wells currently stand at $168 billion (this counts only 401K plans over $100 million). This would be +16% on the firm's current assets-under-contract of $1.04 trillion. Thinking about a 2 year conversion rate at 13.3% of future assets-under-contract to assets-under-management (at the firm's current realization rate and net margins), put the Wells opportunity at $0.11 in earnings per share. The firm's TTM EPS is currently $0.93, putting the full potential at +11% accretion.

 

Financial Engines (FNGN) | Finally the Wells Notice - Short Interest and Days to Cover Keep Us Long - chart 1 wells fargo

 

The quarterly print was otherwise in line with the firm hitting adjusted earnings per share estimates and maintaining its top line and EBITDA guidance on an operational basis. The firm's slightly adjusted its top line and EBITDA guidance on an annual basis by $1 million lower (not really worth talking about) solely due to lower average market levels between the 1Q to 2Q print. Annual top line guidance is now $314-320 million from $315-321 million prior with EBITDA guidance settling at $96-100 million from $97-101 million prior. What was encouraging in the quarter, was that absolute new assets from new enrollment during 2Q again reached record levels at $6.5 billion. While a growing base of assets-under-contract assists this production, the conversion rate of AUC to AUM over a 26 month period also ticked up to 13.3% from 13.0% in 1Q15.

 

Decomposition of the firm's net AUM additions versus subtractions displayed another high in quarterly net enrollments at $6.5 billion (chart below is in $MM): 

Financial Engines (FNGN) | Finally the Wells Notice - Short Interest and Days to Cover Keep Us Long - chart2

 

The 26 month enrollment rate from AUC to AUM also matched a new high at 13.3% 

Financial Engines (FNGN) | Finally the Wells Notice - Short Interest and Days to Cover Keep Us Long - chart3

 

While external realization rate calculations (fee rates) are not that accurate, with AUM and AUC blending into the financials at different times outside of the GAAP reporting periods, investor fears of substantial fee degradation are not justified. Our calculation of the firm's quarterly realization rate remained at 28 basis point for the quarter, in line with 1Q levels and down just 1 basis point year-over-year. Generally, most bearish views on the stock have pricing assumptions declining rapidly into the mid teens which just simply isn't happening yet. We are comfortable that we have put forth a reasonable out year estimate with realization rates on AUM at 25 basis points (assuming some reasonable pricing declines).   

 

Financial Engines (FNGN) | Finally the Wells Notice - Short Interest and Days to Cover Keep Us Long - chart 4

 

The market internals for the stock are still way too bearish and with over 25% of the float short, we continue to see asymmetric upside. Historically, the 20% short interest level has been the buy signal in FNGN stock, which has remained the case throughout the course of this year. In addition, with trading volume having dried up over the past 90 days, the days to cover has now doubled this year to 40.2 days.

 

Financial Engines (FNGN) | Finally the Wells Notice - Short Interest and Days to Cover Keep Us Long - chart 5

 

Financial Engines (FNGN) | Finally the Wells Notice - Short Interest and Days to Cover Keep Us Long - chart 6

 

Financial Engines (FNGN) | Finally the Wells Notice - Short Interest and Days to Cover Keep Us Long - chart 7

 

FNGN stock continues on our Best Ideas list as a Long position with fair value at $55 per share. We are valuing shares on an assets-under-contract opportunity of $1.3 trillion. With the new Wells announcement already getting us half way there, and the ongoing overly bearish market structure of the stock, we continue to see upside.

 

Financial Engines (FNGN) | Finally the Wells Notice - Short Interest and Days to Cover Keep Us Long - chart 8

 

 

Revving up on Network Providers

Low Water Mark with Increased Guidance

DOL Making Sure Retirement Accounts Aren't DOA

Best Idea Call Replay

Financial Engines Best Idea Long Black Book

 

 

Jonathan Casteleyn, CFA, CMT 

 

 

 

Joshua Steiner, CFA

 

 

 

 

 


August 6, 2015

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BULLISH TRENDS

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BEARISH TRENDS

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WEN | Performing Well for Now

Wendy’s (WEN) was added to our SHORT bench as a result of our LONG thesis on McDonald’s. We still believe that it might be adversely affected by the resurgence of McDonald’s, but it’s not time to go SHORT on WEN yet.

 

Yesterday, WEN reported 2Q15 results, for the most part outperforming consensus, but as management put it, has room to improve on their value offering. The company-owned comp was +2.4% versus consensus of +1.7%, a 150bps decline YoY. This quarter was their toughest comp of the year at +3.9%, comps get easier in the 2H of the year. Total company revenue of $489.5mm beat consensus of $486.3mm, representing a decrease of -6.5% due to refranchising efforts. Company-owned restaurant level margins increased 40bps to 18.2%, beating estimates of 18.1%. Adjusted EPS came in at $0.08 below consensus of $0.09, representing an -11% decline YoY.

 

WEN | Performing Well for Now - 2Q15 CHARTS

 

Reimaged stores are having a strong impact, seeing 10-15% sales increases post completion, with 40-50% of that flowing through. Newly remodeled stores drove 170bps of the system-wide same-restaurant sales growth of 2.2%, which was above estimates of 1.6%. Management stated they are continuing to see strong results from core menu items and LTO’s. Recently introduced a refurbished chicken sandwich featuring new marinade and antibiotic free chicken, in certain test markets and hoping they can bring it system-wide. The company is notably having difficulties with price and value on some items, and working to fix it with value bundles in the $4-$6 check range. 

 

The company continues to invest in technology to improve customer interaction. They view Mobile Order & Pay and Self-Order Kiosks as a great ways to offset wage inflation, as well as improve the quality of the food and experience for the customer. Just staying on the wage topic for a moment, management was adamant that they do not, and their franchisees do not intend to pass a majority of this increase onto customers in the form of pricing. They will work on reducing staff, reducing hours, in general getting smarter around labor management. Management went as far as to say, “these wage increase will in the end hurt the very people they are intended to help.”

 

The hot topic in restaurants, the REIT was broached in this call, but largely pushed to the side by management. By 2017 they anticipate receiving $170mm a year in rental revenue, which is a strong dependent revenue stream they don’t want to get rid of.

 

MANAGEMENT OUTLOOK

WEN increased their outlook for 2015 adjusted EBITDA to $385mm to $390mm from its prior guidance of $375mm to $390mm, representing an 8% to 9% increase compared to 2014. The company also increased their outlook for restaurant operating margins by 50bps to 17% to 17.5%. EPS estimates remained constant at $0.31 to $0.33. The planned sale of 540 domestic company-operated restaurants is on schedule, and expected to provide $400mm-$475mm in pre-tax proceeds. Additionally, the company entered into an accelerated share repurchases transaction for approximately $165mm as part of a previously approved share repurchase authorization.

 

HEDGEYE OUTLOOK

We continue to think that looking out 1-3 quarters WEN sales will start to take a hit from the resurgence of McDonald’s. Until that happens this company will perform in line with expectations, comping at the 2.0% to 2.5% range. When MCD starts taking share, WEN will not be immune, it seems like the first company to get value right will win this race, our bet is on MCD. 


Daily Trading Ranges

20 Proprietary Risk Ranges

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RL | Two-Bagger or Value Trap?

Takeaway: RL is setting up to be a two-bagger, or the Mother of all Value Traps. We’re inclined to think the former. It’s all ‘bout mgmt. Stay tuned.

We said earlier this summer that we liked RL as a TRADE into today’s print. Fundamentally, the call played out – though we’re about flat on the stock.

 

Let’s get one thing out of the way…this RL quarter was horrible. Yes, it beat muted EPS expectations by $0.10. But revenue was down 5.3%, gross profit -7.1%, SG&A UP +4.3%, and EBIT/EPS down ~40%. Think it can’t get any worse? Think again, the cash conversion cycle is sitting  at 171 days, which is 26 days worse than last year. Finally, capex is up 25% this year, which is the icing on a really bad tasting cake. Put ‘em all together – P&L down 40% and Balance Sheet +25%, and you get RNOA of 13%, down 1,000bp vs last year.

 

Then why are we incrementally warming up to RL?  When it comes to consumer brands and retailers, some of the best longs we’ve seen (ones that double, and then double again) start with

a) positive rate of change in the balance sheet, which frees up cash to…

b) improve margins while investing in the content/Brand, and ultimately…

c) accelerate the top line. The stock will usually seem expensive early on in this process, and that’s where RL is today, as it’s trading at 17x a declining earnings stream.

 

We’ll very rarely give any company the benefit of the doubt for being able to turn such a value-eroding algorithm around – but Ralph Lauren is perhaps one of them.  The reality is that it is a brand with an aggregate value at retail of $15bn, and as the company positions its resources around its core assets on a global scale, we should see growth return, and Brand footprint go through $20bn. Specifically, as it relates to the criteria above…

a) on the Balance Sheet we should see Capex coming down next year by 25%, or about $100mm as spending on SAP, which should subsequently take the Cash Cycle down by a minimum of 25 from here (that’s $200mm in cash)

b) on the Margin line, we should see a lift from the 11.5% where it’s targeted to come in for FY16. For the record, that’s the lowest margin level –by a third – since 2005 when it faced dilution from integrating licenses(most by Jones Apparel Group).

c) better productivity in company-operated stores and e-commerce alone could add $3bn to consolidated sales – nevermind better efficiency in wholesale doors.

 

When all is said and done, in 2-3 years we could be looking at $9.5bn in sales, 15% EBIT margin and $11-$12 in EPS. The CAGR that would require such growth (25-30%) would arguably support a 20-25x multiple on $11+ in earnings. That’s when RL becomes a two-bagger.

 

All that said, we have to get comfortable with one thing, and one thing alone – and that’s management. We outlined the risks to that part of the story in our recent vetting book [LINK: CLICK HERE]. Aside from the fact that RL has the seventh oldest CEO in the S&P – and one who is more active today than ever in the day to day operation of the company, there are six new divisional presidents who need to learn their own job as well as hire and subsequently motivate teams of expensive people to be productive. That’s not a 1-2 quarter phenomena.  

 

We’re going to take RL up another notch on our Idea List, and will further vet the management angle before adding it to our Best Ideas.


McCullough: Just Say No To Losing Money

On The Macro Show today, Hedge CEO Keith McCullough defended his track record on calling out late-cycle economic and market conditions amid a sea of perpetually bullish research on Wall St.

 

Subscribe to The Macro Show today for access to this and all other episodes. 

 

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