Takeaway: Fade the CAT bounce. We see another +25% relative downside in the name.
We’ve been negative on Caterpillar (CAT) since mid-2012 when we launched on CAT. Our Industrials Sector Head Jay Van Sciver has been out in front of the name and followed up the company’s Q2 results with a note titled, “CAT: It Gets Worse From Here.” That pretty much says it all.
* * * * *
Over the weekend, Barron’s ran an article suggesting hope for the stock. We disagree. There was a lack of proper historical context (e.g. resources-related capital investment cycles are closer to thirty years, not three) as well as complete disregard for what we see as one of the key risks – Cat Financial, where margins are in decline and loan loss reserves on the rise, as well as building used equipment in several key product categories.
On a related note, one of the best visuals Van Sciver highlighted in his June 17th Black Book is the list of Cat Financials’ major mining accounts – it’s not exactly a picture of health.
Bottom line: We see another +25% relative downside in the name and suggest taking advantage of any bounce (like today’s Barron’s “pop”) as an opportunity to move out of the name.
**If you would like to view our research on CAT (including Jay Van Sciver’s recent Black Book) or are interested in learning more about Hedgeye’s institutional research, please send an email to email@example.com.
Takeaway: Investors continue to favor international equity funds, which took in +$3.8 billion last week maintaining a perfect inflow streak for 2015.
This note was originally published August 06, 2015. Click here for more information on how you can begin your Hedgeye subscription today.
Investment Company Institute Mutual Fund Data and ETF Money Flow:
In the 5-day period ending July 29th, investors made net withdrawals from most asset classes but continued to allocate to international equity funds with a +$3.8 billion contribution. Investors have made positive subscriptions to international stock funds every week so far in 2015 aggregating to +$88.5 billion year-to-date. The source of funds continues to be domestic equities, with redemptions in 24 of 30 weeks so far in 2015. Year-to-date withdrawals in domestic stock funds now total -$83.5 billion, the worst 30 week start to any year this cycle. Additionally, investors have been backing off fixed income recently with fund flows to total fixed income mutual funds and ETFs having been negative in 6 out of the past 8 weeks.
In the most recent 5-day period ending July 29th, total equity mutual funds put up net outflows of -$1.4 billion, trailing the year-to-date weekly average inflow of +$166 million and the 2014 average inflow of +$620 million. The outflow was composed of international stock fund contributions of +$3.8 billion and domestic stock fund withdrawals of -$5.2 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 outflows of -$4.7 billion, trailing the year-to-date weekly average inflow of +$1.7 billion and the 2014 average inflow of +$929 million. The outflow was composed of tax-free or municipal bond funds withdrawals of -$88 million and taxable bond funds withdrawals of -$4.6 billion.
Equity ETFs had net redemptions of -$1.9 billion, trailing the year-to-date weekly average inflow of +$2.3 billion and the 2014 average inflow of +$3.2 billion. Fixed income ETFs had net inflows of +$384 million, trailing the year-to-date weekly average inflow of +$916 million 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 materials XLB ETF saw the highest percentage net withdrawal last week of -3% or -$65 million.
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 +$998 million spread for the week (-$3.3 billion of total equity outflow net of the -$4.3 billion outflow from fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52-week moving average is +$1.7 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 -$18.1 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
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Lifeway Foods (LWAY) is on the Hedgeye Consumer Staples LONG bench.
LWAY has been on our “to do” list for some time. We have had it on our LONG bench. Following WWAV’s acquisition of the Wallaby Yogurt Company, which sells Kefir beverages there might be some increased interest in LWAY.
The probiotic segment is at the early stages of growth and looks to be the next major growth category within the $275 billion “fortified/functional foods” segment (according to Euromonitor.) In a recent survey by NPD Group, 31% of Americans said they wanted to ingest more probiotics. Therefore, it’s not surprising to know that three companies (Nestle, General Mills and Danone) are aware of this opportunity and spending significant R&D dollars aimed at this segment. Danone is the world’s largest yogurt producer and none of its products sells better than Activia, the probiotic-enhanced yogurt launched in 1987. In 2014, sales of Activia were $2.4 billion.
Lifeway, a market leader in the Kefir segment, is dealing with an onslaught of competition from smaller players within the natural channel. Brands such as Siggi’s, Wallaby, Goodbelly, and a few other regional brands. The fact is, competition comes where there is a good idea and prospect for growth. Lifeway and their competition are early in the growing market of probiotics, but the race is on to see who will dominate the category.
It does not take long to realize that Lifeway’s current management team does not have the skill set capable of keeping them in the leadership position. Significant changes are needed to take full advantage of the market opportunity.
The LONG thesis on LWAY is predicated on the company being acquired, given the families control, it is unlikely they would give up control to an externally hired CEO. Current founders, the Smolyansky family, own 49.7% of the company, with co-founder Ludmila (mother) owning 44.7% of that, working in an advisory role. Daughter, Julie is the President, CEO & Director and the son, Edward, is the COO, CFO, Secretary, Treasurer & CAO. They are clearly in way over their head, and will have trouble taking this company to the next level on their own. Their father (deceased in 2002) has led them to a gold mine, but they don’t have any tools to get the gold.
The x-factor is that Danone owns 21.1% of the company currently (acquired the stake in 1999), and although they shrugged off the idea of acquiring this business in the past, they have to be thinking about it more seriously now. When thinking about other possible acquirers, General Mills (GIS) comes to mind, given their strong presence across the yogurt category, they don’t yet have a Kefir product. They could make one themselves utilizing the Liberte or the Yoplait brand, but Lifeway would afford them immediate expertise and distribution.
LWAY hasn’t reported numbers for 1Q15 or 2Q15 and are still working through it with the SEC. We have received word from their IR representative that this issue is as close as a month from being resolved and they will soon be in compliance with the SEC. Although we have no picture on how the business is doing over roughly the last 6 months, we are confident in the growth trajectory in the category they participate in as a leader.
We would tread with caution on this one. Although this is the top brand in the category, it is not possible for us to endorse the management team as it stands today. The market place is getting more competitive so we are waiting and watching to see how things unfold. Additionally, LWAY needs to be in compliance with its filings and we need to get a better handle on the numbers before going all in on this one.
Takeaway: Junk bonds yields continue to blow out while commodity prices plumb fresh lows. Meanwhile, China catches a breather.
The US high yield and leveraged loan markets continue to back up. High yield rose another 12 bps on the week (+38 bps M/M), hitting 7.06%). Rates are backing up on both credit and rate fears. Credit fears are flowing largely from the energy borrowers, who are now on the wrong end of 12+ months of crude and nat gas's price slide. Rate fears reflect the asymmetry of the Fed's current position.
We've been watching China closely as a global catalyst and causal determinant of commodity prices. Interestingly, the two diverged this week. China got a little less bad on the margin (Chinese Steel prices +4.9% W/W & +11.3% M/M), while commodity prices generally (CRB) pushed to new lows (-3.5% W/W and -9.1% M/M).
Financial Risk Monitor Summary
• Short-term(WoW): Negative / 2 of 12 improved / 2 out of 12 worsened / 8 of 12 unchanged
• Intermediate-term(WoW): Positive / 6 of 12 improved / 4 out of 12 worsened / 2 of 12 unchanged
• Long-term(WoW): Positive / 3 of 12 improved / 1 out of 12 worsened / 8 of 12 unchanged
1. U.S. Financial CDS - Swaps widened for 17 out of 27 domestic financial institutions. Genworth Financial reported disappointing earnings, especially in its mortgage services and U.S. life divisions, last Tuesday. Following that, CDS on the company's debt widened by +152 bps to 459.
Tightened the most WoW: CB, ACE, AXP
Widened the most WoW: GNW, ALL, MET
Tightened the most WoW: ACE, CB, AXP
Widened the most MoM: GNW, MMC, MBI
2. European Financial CDS - As is often the case, Greek banks tend to sway the mean for the EU banking complex. The median is, therefore, the better measure. The median change in swaps was +2 bps on the week. Greece's equity market reopened last Monday and subsequently tumbled. Not surprisingly, the country's banks swaps followed suit, widening by +16 to +3,338 bps W/W.
3. Asian Financial CDS were mixed last week. Indian bank swaps rose +3 to +10 bps, while banks in Japan and China were little changed.
4. Sovereign CDS – DM sovereign swaps were little changed last week.
5. Emerging Market Sovereign CDS – Unlike DM, EM swaps widened notably last week with petro-states Brazil and Russia seeing the most widening, by +33 bps to 326 and +22 bps to 360 respectively.
6. High Yield (YTM) Monitor – High Yield rates rose 12 bps last week, ending the week at 7.06% versus 6.94% the prior week.
7. Leveraged Loan Index Monitor – The Leveraged Loan Index fell 6.0 points last week, ending at 1876.
8. TED Spread Monitor – The TED spread was unchanged last week at 25 bps.
9. CRB Commodity Price Index – The CRB index fell -3.5%, ending the week at 198 versus 205 the prior week. As compared with the prior month, commodity prices have decreased -9.1%. We generally regard changes in commodity prices on the margin as having meaningful consumption implications.
10. Euribor-OIS Spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States. Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal. By contrast, the Euribor rate is the rate offered for unsecured interbank lending. Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread was unchanged at 10 bps.
11. Chinese Interbank Rate (Shifon Index) – The Shifon Index rose 6 basis points last week, ending the week at 1.53% versus last week’s print of 1.47%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.
12. Chinese Steel – Steel prices in China rose 4.9% last week, or 110 yuan/ton, to
2349 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity and, by extension, the health of the Chinese economy.
13. 2-10 Spread – Last week the 2-10 spread tightened to 144 bps, -7 bps tighter than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.
14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 0.7% upside to TRADE resistance and 0.8% downside to TRADE support.
Joshua Steiner, CFA
Jonathan Casteleyn, CFA, CMT
8/10/15 WWAV | KEEP RIDING THIS WAVE
8/4/15 BETR | It’s Already Popped
RECENT NEWS FLOW
Friday, August 7
WWAV | Reported 2Q15 results, which were highlighted by robust organic top line growth of +9%, but missed on the top line slightly. In addition to the impressive quarter, WWAV also acquired the Wallaby Yogurt Company (view our note here)
POST | Reported 3Q15 results in which management mitigated all of the potential disaster Avian Flu could have brought on them, and surprised the street. Most importantly they had great things to say about cereal. Declines in RTE cereal are slowing, and they are beginning to see an upward trend. Management noted that their biggest over performance versus expectation was in the RTE cereal category. As the industry is cycling over easier comps, “leaders in the category [GIS & K] seem to be reinvigorating their spending behind the category and it seems to be working.” (click here for news release)
Wednesday, August 5
K | Upgraded to buy from neutral at Citi, target increased to $80 from $66
Tuesday, August 4
HSY | Introduces latest BFY granola bar offering (click here for article)
Food and organic stocks that we follow outperformed the XLP last week. The XLP was down -0.3%, the top performer from our list was Boulder Brands (BDBD) posting an increase of 11.3%, after announcing the engagement of William Blair to explore strategic alternatives for some of their brands. Worst performing company on our list was Amira Natural Foods (ANFI), which was down 21.7%.
From a quantitative perspective, the XLP remains bullish on a TRADE and TREND duration.
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