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"It's Harder Than It Looks" | Private Investor Buddy Carter Talks Shop with Hedgeye Interns

Former Goldman Sachs trader and one-time finance Twitter superstar Buddy Carter returns to Hedgeye to give an in-depth presentation and Q&A session for our intern class.

 

Throughout the presentation, Buddy offers recommended reading, the importance of predictability to your method and how he tries to make better-than-average decisions in his own trading. This presentation is full of insights appropriate for investors at any level.

 

One Key Tip: Math has never been so important.


Investing Ideas Newsletter

Takeaway: Current Investing Ideas: RH, XLU, LNKD, UUP, ZOES, FNGN, DXJ, HOLX, FL, VIRT, PENN, GIS, VNQ, EDV & TLT

Investing Ideas Newsletter       - Deflation cartoon 08.03.2015

 

Below are Hedgeye analysts’ latest updates on our fifteen current high-conviction long and short investing ideas as well as CEO Keith McCullough’s updated levels for each.  

 

Please note we added RH (Restoration Hardware), XLU (Utilities Select Sector SPDR Fund) and LKND (LinkedIn) this past week. 

LEVELS

Investing Ideas Newsletter       - table

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

IDEAS UPDATES

RH

Please note we added Restoration Hardware (RH) to Investing Ideas on Friday. Click here to read Hedgeye CEO Keith McCullough's explanation, a Stock Report detailing the fundamental view will be published later.

LNKD

We added LinkedIn (LNKD) to Investing Ideas earlier this week to read the full Stock Report click here.

 

LNKD continues its post-print sell-off following undue conservatism on its 2015 guidance. The issue is that LNKD is crying wolf two quarters in a row, and some are concerned that there is a bigger issue at work, or that management will continue to hamper the stock with undue conservatism. LNKD’s fundamentals remain solid, and we believe it salesforce investment will pay off in 2H15. More importantly, we suspect management has learned its lesson, and there won’t be any ambiguity on its next guidance update.  

 

 

ZOES

We view ZOES as one of the best small cap growth names in the Restaurant category. The company is set-up for long-term success for the following reasons:

  1. Superior brand positioning
  2. Management philosophy and execution
  3. Unit opening geographic profile
  4. Early-stage average unit volumes and returns

 

FNGN

Financial Engines (FNGN) formalized the announcement of Wells Fargo providing their independent advisory services in their 2Q15 earnings presentation this week. 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." 

 

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), puts 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.

 

The market internals for the stock are still way too bearish in light of this announcement 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. 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.

 

The Wells Fargo announcement this week is providing access to another $160 billion of 401K assets under administration to sell into for FNGN. Wells is currently the 5th largest 401K administrator, providing a solid opportunity for Financial Engines:

 

 Investing Ideas Newsletter       - chart13

 

Historically, the 20% short interest level has been a good buying point for FNGN, a level where the 2015 ascent in the stock started again. The current short interest percentage is 25%, again a good entry for stock bulls.

 

Investing Ideas Newsletter       - chart14 

HOLX

HCA had some potentially chilling commentary on their earnings call this week and introduced a new term, #ACATaper. The pace of growth in the U.S. Medical Economy has been on a tear as the newly insured rolled into physician offices and hospitals. We’ve been highlighting in recent weeks the transition from an #ACATailwind to #ACAHeadwind, or as someone on the HCA call named it, the #ACATaper.   

 

In an analysis of the demographics of the newly insured, Pap testing, HPV, and mammography were at the top of the list of products that would be positively impacted by the ACA.  As we reach the #ACATaper stage, will HOLX take a hit to their Diagnostic segment? It is possible, in our view, but so far a minor risk.  As we learned last week from a lab operator, Qiagen is likely to continue to cede their 14% HPV testing share to HOLX. So while the #ACATaper appears to be finally here, there are offsets. 

 

On a disappointing note, our 3D Tomo Tracker update for July came in at 24 facilities. Down sequentially from June, and down from a peak of 54 in May. Our forecast algorithm, which is based on these updates, remains unchanged. While 20 is low, it is probably a blip in the longer term adoption cycle.  Also we analyzed the MQSA data (http://www.fda.gov/Radiation-EmittingProducts/MammographyQualityStandardsActandProgram/FacilityScorecard/ucm113858.htm) which strongly suggests facilities are purchasing ~2 mammography units each, which is above our current estimate.

 

Investing Ideas Newsletter       - slide3 

FL

We’re coming off a six-year period where taking capital away from the business improved productivity and profitability. This happened while industry margins staged a massive recovery, and increased Nike allocations (now 73% of purchases and close to 80% of sales) drove FL’s ASP (Average Selling Price) higher. Sales, margins, ROIC all benefitted. 

 

 Investing Ideas Newsletter       - FL Nike 8.7.15

 

The athletic footwear industry’s 12-year ASP cycle is getting long in the tooth. If it continues, it is going to accrue more to the brands (Nike, Adidas, Skechers, Under Armour) – not the retailers. Now FL has to inject capital (largely through remodels), and hope revenue follows. Aside from gas prices, there are no more margin tailwinds. The Nike ratio can’t go much higher than 80%. Ken Hicks pushed the enhanced Nike agenda; seeing the positive Nike ASP/margin impact approaching peak likely played a role in why he cashed out.

 

 Investing Ideas Newsletter       - FL ASP 8.7

 

DXJ

In Japan, the key highlight (or lowlight, if you will) of the week was the BoJ’s decision to leave its monetary policy unchanged on Friday, as expected. The board also reiterated its optimistic outlook for the economy, as was also expected. Given the in-line nature of the event, there was little reaction in the market place following the release or Kuroda’s press conference.

 

Elsewhere in Japan, this week’s July PMI data came in mixed and highlights the uneven and fragile nature of Japan’s recovery. Specifically, the manufacturing/production/export side of the economy continues to hum along, while services/consumption economy peters out amid tepid wage growth – effectively netting out to stagnation.

 

 Investing Ideas Newsletter       - Chart 6 MANUFACTURING PMI

 

 Investing Ideas Newsletter       - chart 7SERVICES PMI

 

 Investing Ideas Newsletter       - chart 8COMPOSITE PMI

 

All told, we reiterate our bullish bias on Japanese shares (DXJ) and expect QQE expansion by year-end/early-2016 as both reported inflation and inflation expectations continue to trend lower. We like the fact that Japan had been showing cyclical improvement, but the backstop of easier monetary policy is also supportive to the extent the rate-of-change in Japanese growth flat-lines. 

 

 Investing Ideas Newsletter       - chart 9 CPI

 

 Investing Ideas Newsletter       - chart 10CORE CPI

VIRT

The short case on Virtu Financial (VIRT) started this week with an earnings miss and a sizeable decline in the firm’s important foreign exchange (FX) business. The company missed overall 2Q15 expectations by 10% on the top line and 15% on the bottom line in only the second publically traded quarter for the firm. The big eye sore in the release was the firm’s FX business which dropped -43% sequentially with daily revenue production hitting just $392,000 per day from $691,000 per last day quarter. While sequential machinations in trading businesses are quite usual, the flat year-over-year growth in FX (at 25% of top line revenue) is not enough to support the stock’s sky high multiple.

 

While the -10% drop in VIRT shares following the release is to be expected, we still  see further downside. The company runs a cyclical trading business (proved out by this week’s results) on very thin levels of capital, on top of a multi-level shareholder structure (the newly public Class A shareholder group has just 11% economics of the business and only 2% voting power). The long term implication is that if there were ever a trading loss within operations the company would struggle with liquidity and the long term returns of stocks with multi-class equity structures is just half of single class structure. We see incremental downside of between -10-40%.

 

Long term returns of controlled companies have averaged just over half that of non-controlled companies:

 

Investing Ideas Newsletter       - Chart11

 

Depending on how we toggle earnings power and the stock’s multiple, fair value is 10-40% lower (we already got a 10% move down this week):

 

Investing Ideas Newsletter       - chart12

 

 

PENN

PENN has emerged as the first domestic gaming growth story in 10 years with a new casino in Massachusetts this year and one in San Diego next year. Meanwhile, regional gaming trends have stabilized, providing near term earnings visibility and upside. Upcoming catalysts include the monthly release of State gaming revenues for July, including Massachusetts, and positive earnings revisions.

 

 

GIS

General Mills (GIS) remains one of our favorite names in the Consumer Staples sapce.

 

FY16 Hedgeye Guidance ―

Looking into FY16 we are excited about the possibilities. Management is working hard on their “Consumer First” initiative and making great changes to current product while also introducing new products. Below is not a comprehensive list but some of the biggest things that we are looking forward to this year:

  1. Yoplait in China
  2. Gluten-Free Cheerios
  3. No artificial colors or flavors in the cereal
  4. Granola innovation / Muesli
  5. Greek Plenti / Whips
  6. Original yogurt sugar reduction
  7. Renovation on Grain Snacks
  8. Strong push on Natural & Organic products
  9. Delivering Value to consumer on brands like Totino’s and Hamburger Helper
  10. Bringing U.S. innovation International

Bottom line is they are still struggling; we don’t want to shy away from that. But the core of the portfolio is growing and management seems to be working tirelessly on implementing changes to grow the rest of the portfolio, especially cereal. We also still believe that to have continued growth into the future a sizeable acquisition or divestiture would be beneficial to the business. 

UUP

In the context of our #LateCycle slowdown thesis on the domestic economy, our bullish bias on the dollar continues to be centered on the structural divergence in G-3 monetary policy.

 

Specifically, with the Fed allegedly gearing up to make a policy mistake by raising rates in September  (see: Atlanta Fed President Lockhart’s hawkish commentary), there exists a cavernous gap between Fed and BoJ/ECB monetary policy.

 

With key commodity prices taking another sharp leg down of late (e.g. the CRB Index dropped another -2% WoW and is down -8% MoM), the key development to highlight this week is the recent decline in inflation expectations globally (10Y breakevens):

 

  • U.S.: -8bps WoW and -22bps MoM to 1.66%
  • Japan: -1bps Wow and +1bps MoM to 0.95%
  • Germany: -10bps Wow and -14bps MoM to 1.11%
  • France: -10bps WoW and -18bps MoM to 1.20%
  • Italy: -6bps WoW and -10bps MoM to 0.96%
  • Spain: -6bps Wow and -12bps MoM to 0.96%

 

Going back to the policy divergence theme, it’s worth highlighting that the Fed is substantially closer to achieving its +2% inflation target than either the BoJ or ECB are to achieving theirs, which implies considerable scope for the BoJ’s QQE program and the ECB’s QE program – which remain ongoing, targeting LSAP of ¥80T/yr and €60B/mo, respectively – amid the Fed’s rhetorically hawkish bias (misguided as it may be).

 

Investing Ideas Newsletter       - Chart11

 

From the perspective of foreign exchange market participants, the U.S. remains the “best house in a bad neighborhood” and we remain bullish on the U.S. dollar (UUP) as a result.

 

 

TLT | VNQ | EDV | XLU

Please note we added XLU (Utilities Select Sector SPDR Fund) to Investing Ideas on Thursday to read the full Stock Report click here.

 

Sometimes the macro rotation and allocation playbook is relatively straightforward. As growth slows and "reflation" deflates, you want to be buying A) Long-term Bonds and B) stocks that look like bonds. Bond proxies and defensive yield consistently outperform alongside the dual deceleration in demand and prices and Utilities and REITS remain the go-to sectors for growth slowing, defensive yield exposure.  

 

 


RH: Adding Restoration Hardware to Investing Ideas (Long Side)

Please note we are adding RH to Investing Ideas today. CEO Keith McCullough explains why below and a Stock Report detailing the fundamental view will be published later.

 

*   *   *   *   *

 

The week started with momentum guys chasing U.S. Retailer charts on the "lower gas prices" meme (and it ended in tears). But we don't want to be sad about that. We want to be glad and celebrate the end to a good week by doing the one thing that so many Americans should love - buying things on sale (at the low-end of the risk range).

 

RH: Adding Restoration Hardware to Investing Ideas (Long Side) - RH

 

Our Retail & Apparel analyst, Brian McGough, has been bullish on RH for a very long time. His long-term bull case is now considering whether or not this is going to be a $300 stock. Last month he published a "Black Book" (deep dive) to our Institutional Research subscribers that considered some of the following topics:

 

  1. Why Wall Street is looking at the business wrong, and therefore underestimating the revenue opportunity.
  2. Quantifying the opportunity for RH Modern.
  3. Comparing the size of new Design Galleries to consumer spending levels around each new store.
  4. Is the introduction of these new concepts/classifications changing the growth algorithm and required footprint of each store? (Answer: Yes). Both a challenge and opportunity.
  5. New stores we're most excited about, and stores where we're more concerned.
  6. New market pipeline -- how many stores, how big, and how much revenue?
  7. Competitive landscape -- and how it's changing
  8. Gross Margin impact from occupancy leverage, and why we think the Street is too low. 

 

Buy Red,

KM

 


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BOJA | BO’S DILEMMA

BOJA is still one of our Best Ideas on the SHORT side

 

BOJA reported a decent quarter, but the trends in the quarter raise a RED flag for a company trading at a fast casual multiple of 17x EV/NTM EBITDA.

 

The goal of every restaurant company should be to grow long term sustainable increases in traffic trends or customer counts.  For the past three years, positive traffic has eluded BOJA.

 

Thus Bo’s dilemma – the concept can’t increase traffic trends year-over-year without significant discounting.  Bo’s dilemma is shared by nearly every “mature” restaurant concept we know.  In 2Q15, BOJA drove increased profitability by discounting less versus 2Q14, but that resulted in a 90bps drop in traffic in 2Q15.  So we conclude, that given the operators desire to grow traffic long term, the current level of profitability is unsustainable, as the discounting and lower margins will return!

 

The sensitivity to discounting and the company’s inability to drive traffic is troubling.  On an annual basis the company has not been able to drive traffic without discounting for the past three years (the only years we have data for.)  As such, the company should be trading at a significantly lower multiple relative to its peer group. 

 

SUMMARY

BOJA reported a “beat and rise” 2Q15 EPS of $0.23 vs consensus $0.16.  Although the system-wide comps of +4.4% beat the consensus estimate of +3.6%.  A miss came from the company stores reporting +3.3% vs the estimate of +4.1%, which represents 40% of locations.  The franchise same-store sales were +5.1% vs consensus of +3.6%, representing the other 60% of locations.  With sales being a little light the company reported revenue of $114.0M vs an estimate of $114.6M

BOJA | BO’S DILEMMA   - CHART for 2Q15 Earnings Note

 

Less discounting and deflation helped food and supplies decrease to 32.2% vs the consensus estimate of 34.0%.  With labor leverage the company reported restaurant margin 19.1% vs the consensus estimate of 16.3% and “adjusted” EBITDA margin of 17.1% vs consensus of 13.5%.

 

GUIDENCE

  • EPS $0.75-$0.78 vs consensus $0.69
  • The company reaffirms comps up low to mid-single digits
  • Revenue $483.5M-$487.5M vs prior $480M-$487M and FactSet $486.9M
  • EBITDA $74M-$76M vs FactSet $67.3M
  • The company increased new store openings slightly to 50-57 new system restaurants (22-25 company and 28-32 franchise)

Squishy | July Employment

So, the squishy and amorphous “some further [labor] improvement” remains the lift-off bogey for a self-described quantitative, data dependent Fed.  On balance, the July employment data probably met that nebulous criteria threshold.  Speculative angst is free to crescendo into the Sept 17th FOMC announcement.    

 

The Annual Hedgeye Summer party starts in T – 10 minutes and we’re not particularly big on adding to the noise of manic data reporting on employment Friday, so we’ll keep it tight with the summary highlights below.  If you have any specific questions or would like to dig/discuss a particular dimension of the labor market in more depth, let us know. 

  • Payrolls | Best Before the Crest:   NFP and private payrolls slowed both sequentially and in rate of change terms.  May/June get a net positive revision of +14K.   While moving past peak rate-of-change in payroll growth does not herald an imminent roll in the eco cycle, the reality is that we’re late cycle in the current expansion and the labor party is always best before the crest.    
  • Unemployment Rate | Less Bad:  The Unemployment Rate was flat sequentially at +5.3% but the internals were largely positive as the participation rate held steady and the labor fore rose with the chg in employment > chg in unemployed.  The U-6 rate (underemployment rate) dropped a tick to 10.4% with PT involuntary workers declining -180K.  
  • Wages |  Up … But Not Really:   Both Total Private & Nonsupervisory Worker wage growth accelerated sequentially but the gain just represents more oscillation above & below middling.  Not what Team Janet wants to see although they’ve been making an attempt at quasi-marginalizing the trend in wage growth on policy decisions (see March Speech to review that commentary) 
  • Hours Worked | Prepare the Punditry:    This will probably be the favorite pundit talking point – and with some justification.  Average weekly hours worked rose by a tenth to 34.6hrs; the first increase in 5-months.   Income = Hours worked * earnings per hour, so why a longer average work week is good for aggregate incomes is straightforward (& that lowly tenth adds up to something material when applied across an employment base of 142MM).  Further, people working more hours is tantamount to more workers working the same hours – a concept termed “Job Equivalence” or “Labor Usage”  - so you’ll hear the case made that the +215K NFP gain is equivalent to something like a ~350K gain when factoring in the increase in hours worked and taking a job equivalence perspective of the data.  
  • Income | Wages Weak, Income ↑:  In a Keynesian economy, spending is king and the capacity for consumption flows from changes in the aggregate consumer P&L.  One could take two, somewhat divergent, views of this morning’s wage & income data:
    • Wage Growth:  Private hourly Wage growth at 2.1% YoY was better sequentially but below estimates for +2.3% and does nothing to offset the disappointment from the slowdown reported in the ECI last week.  Policy makers disappointment extends yet another month as wage inflation remains in RoC purgatory. 
    • Aggregate Income Growth: On net, the July data will be good for the aggregate income figures when they are reported for July.  Again, the math is trivial:  Flat Employment Gains + ↑Hours + ↑Wage growth = ↑ Aggregate DPI/Salary & Wage growth.  In short, the aggregate consumer P&L improvement will remain ongoing with the savings rate remaining the swing factor for actual HH spending growth.    
  • Housing:  On the supply side, resi construction employment rose by +6K with industry remaining in healthy expansion.  On the demand side, employment growth in the key housing demographic of 25-34 year olds decelerated to 2.3% YoY in July.  Inclusive of the July deceleration, growth in the cohort continues to run at a premium to the broader average and the trend for the cohort remains one of ongoing improvement. 
  • Energy | Eye of the Storm? The Challenger Job Cut data released yesterday showed ~9K in announced cuts in the sector in July.   The BLS data was more equivocal.  The Oil and Gas extraction industry – for which we have data thru July – showed employment rising by 0.5K.  Across the broader sector aggregate – for which we have data thru June – showed net employment falling -5.7K, marking a 7th consecutive month of net decline for a cumulative total of 79K.  Should strong-dollar led energy price deflation continue, we expect a re-acceleration in energy sector job loss as 2015 hedges roll off and commodity price exposure becomes more acute. 

Squishy | July Employment - Employment Summary Table July

 

Squishy | July Employment - 25 34 YOA Employment

 

Squishy | July Employment - Resi Construction Employment

 

Squishy | July Employment - Energy   of NFP

 

Squishy | July Employment - Oil Industry Employment Thru July

 

Squishy | July Employment - Oil Industry Employment Thru June

 

Squishy | July Employment - Challenger

 

Squishy | July Employment - NFP growth vs Earnings Growth

 

Squishy | July Employment - NFP YoYpng

 

 

Christian B. Drake

@HedgeyeUSA



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