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DOMESTIC CRUDE PRODUCTION: LOTS OF IT....STILL

Takeaway: A sequential decline in U.S. production won’t be steep enough to curb the supply glut that will continue into the Fall Season.

To answer our own question on when a domestic production slowdown will give a lift to crude oil prices, a rolling over of U.S. production would have to be much more drastic from a first and second derivative perspective for a fundamental and psychological price floor to develop.

 

Domestic production IS rolling over, but U.S. production remains resilient with production per region continuing to show lopsided Y/Y gains vs. what could (even optimistically) be absorbed:

 

DOMESTIC CRUDE PRODUCTION: LOTS OF IT....STILL - Regional Production and Rig Table

 

The headline numbers from the EIA for monthly production have been scrutinized, but all production reported is subject to more accurate revision. In May and June the EIA upwardly revised previously reported production numbers for March and April. Data reported for August now shows the opposite type of revision. Previously reported production numbers have been downwardly revised.

The most updated production data shows that vs. June’s release, updated production levels for August have been downwardly revised for March, April, May, and June.

 

DOMESTIC CRUDE PRODUCTION: LOTS OF IT....STILL - WTI vs. Production Per Region Chart

 

An ongoing argument continues as to whether the supply glut is in fact an excess of oil being produced or if the demand picture is just that poor. Arguments can be made for both, but for several reasons below we outline why overproduction will continue to overpower both demand for tight oil and infrastructural capabilities in the near future.

Production may be rolling over, but considering the fact that inventories still remain near all-time highs after going through a seasonal summer drawdown where motor gasoline consumption recovered to near pre-crisis levels and refinery capacity utilization touched all-time highs, it’s hard to argue weak DEMAND for refined products is the stronger factor contributing to a supply glut. Even after this week’s big draw, it’s reasonable to expect inventories to move right back to all-time highs, testing the logistical ability to deal with it.

 

DOMESTIC CRUDE PRODUCTION: LOTS OF IT....STILL - Refinery Inputs Vs. Utilization

 

DOMESTIC CRUDE PRODUCTION: LOTS OF IT....STILL - DOE Regional Inventories Bar Chart and Map

 

DOMESTIC CRUDE PRODUCTION: LOTS OF IT....STILL - DOE LT Inventories

 

DOMESTIC CRUDE PRODUCTION: LOTS OF IT....STILL - Motor Gasoline Inventories

 

How much more crude will refineries eat up now that 1) the summer driving season is over; 2) we’re entering refinery maintenance season? Despite a big draw this week, inventories are expected to tick higher by seasonal default, but how much higher can they go anyway?

A newsy topic in the spring, the big build-up in inventories was centered on the Cushing, OK build where inventories are currently +180% Y/Y.  

 

DOMESTIC CRUDE PRODUCTION: LOTS OF IT....STILL - DOE Cushing vs. Agg. YY delta

 

Refiners continue to develop more storage capacity which can’t happen fast enough:

  • Aggregate working crude oil storage capacity is +2.9% Y/Y
  • Tank Farm storage capacity in Cushing is +6.1% Y/Y

Even so, transportation and the light/heavy processing problems in the Gulf are stickier problems that face near term constraints.

If a seasonal inventory build commences, Cushing inventory levels have the potential to move to concerning levels again with the lack of infrastructural ability of gulf refineries to handle a continued increase in crude flows from America’s main trading hub in Cushing.

Refinery maintenance season is around the corner at the same time gulf refineries are trying to reconfigure to adequately handle the influx of tight oil (domestic shale) over traditional, heavier imported crude.  

For evidence of the problem, Genscape estimates that both the Kinder Morgan Crude and Condensate Pipeline and the Eagle Ford pipeline from Eagle Ford to Houston are only running at half of nameplate capacity because of congestion inhibiting crude to bypass Houston to Louisiana refineries via pipeline. Much of it is being transported by barge and oil tankers, a much more expensive form of transportation.  

A new deal like the Swap agreement with Mexico’s state-run Pemex (U.S. swaps tight oil for heavier crude capable of being processed by gulf refineries) will temporarily help the infrastructural mismatch in Houston, but the bottom line is that storage and transportation capacity constraints will creep back into the picture moving into the fall before adequate infrastructure is put in place.

Ex. A currency catalyst to devalue the USD and support prices (which is highly possible for a brief relation trade: see our recent note), we expect deflationary macro headwinds and the fundamental supply picture domestically to continue pressuring a sustained price recovery into the fall season. The forward curve reflects this shift in psychology which usually happens the longer the "unbelievable" becomes a reality. The curve is flatter 1,2,3-years at this lower low than it was at the January and March lows in WTI.

 

DOMESTIC CRUDE PRODUCTION: LOTS OF IT....STILL - forward curve comparison graph

 

DOMESTIC CRUDE PRODUCTION: LOTS OF IT....STILL - 1YR Swap Table

 

Ben Ryan

Analyst

 

 


Got $VIX? Risk Happens Slowly, Then All At Once

For much of the past 3.5 years, the VIX has been range-bound between 10-20, with occasional blips to 25 on front-month contracts.

 

Got $VIX? Risk Happens Slowly, Then All At Once  - z volatility

 

And then it happens...

 

Crash!

Boom!

Bang!

 

Yesterday’s close of 36.02 confirms a bullish phase transition for U.S. equity volatility that is unlikely to go away anytime soon. It's rocketed +213% higher in just one month. The move was eerily reminiscent of the 8/8/11 rip in the VIX that preceded several months of 30+ VIX closes.

 

With the Fed gearing up to make a policy mistake in the coming months, could we be looking at a similar setup?


LNKD: Notes from 10-Q & IR

Takeaway: Post-print color from the 10-Q & IR below. Fundamental long thesis in tact, but a sheepish mgmt team remains the risk.

KEY POINTS

  1. DISPLAY EVAPORATES? IR confirmed that the $34M organic guidance cut was essentially all due to display advertising, citing lack of visibility.  Note that display advertising generated $48M in 1H15 revenues, so by cutting 2015 guidance by $34M, mgmt is essentially assuming that display revenues evaporates overnight in 2H15, which obviously doesn't make sense since display was flat q/q in 2Q15, and 4Q is a seasonally strong quarter.  In short, mgmt just wanted display ad revenues out its guidance.  
  2. LYNDA GROWING FASTER THAN EXPECTED: Mgmt suggested during the Lynda acquisition announcement that Lynda generated $150M in 2014 revenue, "growing at about mid-20% range".  According to data from the 10-Q, Lynda on a stand-alone basis generated $87M in 1H15 revenue (38% y/y growth).  However, we're not sure how that relates to Lynda guidance because of the unknown acquisition accounting impact on deferred revenues.
  3. SALESFORCE RAMP CONTINUES:  According to the 10-Q, Sales & Marketing headcount grew 61% y/y in 2Q15, an acceleration from 51% growth in 1Q15.  IR suggested that ~30% of its ~500 acquired Lynda employees were S&M personnel; after backing that out, we estimate that S&M headcount grew 52%-54% y/y.  We see the ongoing salesforce ramp as an investment given the improving selling environment (see note below for detail and tracker).
  4. ARPU IMPACT MOSTLY FX: IR attributed the 2Q15 slow down in ARPU primarily to Fx, which hampered revenues by 3%. That is the same percentage mgmt stated for 1Q15, so that can't fully explain the slowdown.  We suspect that the surge in net LCS account growth also contributed to the slowdown.  We did learn that 2Q15 net LCS account growth tilted toward SMBs, which could be a slight headwind to ARPU.  However, Fx comps ease in 2H15.
  5. NET-NET, COMES DOWN TO MGMT: No incremental changes to our thesis post 10-Q and IR.  We continue to see upside to 2015 estimates from the ongoing investment in its salesforce into an improving selling environment, which we see as a coiled spring.  However, a sheepish mgmt team remains the concern.  There can't be any ambiguity to guidance on its next print after crying wolf two quarters in a row.  We have relayed that message to company; hopefully it gets that this time around.

 

See the note below for supporting detail/analysis on our long thesis.  Let us know if you have any questions or would like to discuss further.

 

Hesham Shaaban, CFA


@HedgeyeInternet 

  

LNKD: New Best Idea (Long)
07/14/15 08:00 AM EDT
[click here]


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[Unlocked] Keith's Daily Trading Ranges

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[Unlocked] Keith's Daily Trading Ranges - Slide1

BULLISH TRENDS

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BEARISH TRENDS

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FINANCIALS SENTIMENT SCOREBOARD - First American (FAF)

Takeaway: We are flagging First American (FAF - Score: 17) as a long on sentiment and short interest.

This morning we are publishing our updated Hedgeye Financials Sentiment Scoreboard in conjunction with the release of the latest short interest data last night. Our Scoreboard now evaluates over 300 companies across the Financials complex.

 

The Scoreboard combines buyside and sell-side sentiment measures. It standardizes those measures to an index of 0-100, where 100 is the best possible sentiment ranking and 0 is the worst. Our analysis shows that a contrarian strategy can be employed successfully by taking the other side of stocks with extreme readings in sentiment, either bullish or bearish. Once sentiment reaches these extreme levels, it becomes a very asymmetric setup wherein expectations become too high or too low.  

 

We’ve quantified the tipping points for high and low sentiment. Specifically, we've found that scores of 20 or lower have a positive, average expected return while scores of 90 or greater are more likely to underperform.

 

Specifically, our backtest of 10,400 observations over a 10-year period found that stocks with scores of 0-10 went on to produce an average absolute return of +23.9% over the following 12-month period. Scores of 10-20 produced an average absolute return of +11.9%. At the other end of the spectrum, stocks with sentiment scores of 90-100 produced average negative absolute returns of -10.3% over the following 12-months.

 

The first table below breaks the 300 companies into a few major categories and ranks all the components on a relative basis. The second table breaks the group into smaller subsectors and again gives them relative rankings within those subsectors. 

 

This week we're flagging First American (FAF - Score: 17) as a long as our 3Q15 call to "hide out" in Housing favors the title insurers. We are also highlighting Federated Investors (FII - Score: 13) as screening well from both a sentiment/short interest and a fundamental research standpoint (see our latest FII research HERE). FII stock is one of the few asset management stocks that is up year-to-date in 2015.

 

FINANCIALS SENTIMENT SCOREBOARD - First American (FAF) - Sentiment1

 

FINANCIALS SENTIMENT SCOREBOARD - First American (FAF) - Sentiment2

 

FINANCIALS SENTIMENT SCOREBOARD - First American (FAF) - Sentiment3

 

The following is an excerpt from our 90 page black book entitled “Betting Against the Herd: Generating Alpha From Sentiment Extremes Across Financials.”

 

Let us know if you would like to receive a copy of our black book, which explains this system and its applications.

 

BUYS / LONGS: Financials with extremely low sentiment readings of 20 and below on our index (0-100) show strong average outperformance in absolute and relative terms across 3, 6 and 12 month subsequent durations.  Stocks with sentiment ratings of 20 or lower rise an average of +15.1% over the next 12 months in absolute terms.   

 

SELLS / SHORTS: Financials with extremely high sentiment readings of 90 and above on our proprietary sentiment index (0-100) demonstrate a marked tendency to underperform in absolute and relative terms across 3, 6 and 12 month subsequent durations.  Stocks with sentiment ratings of 90 or greater fall in value an average of -10.3% over the next 12 months in absolute terms. 

 

 

FINANCIALS SENTIMENT SCOREBOARD - First American (FAF) - Absolute 12 mo

 

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT


Euro, DAX and Volatility

Client Talking Points

EUR

The EUR/USD is trading down 90 basis points this morning as the prospect of the ECB’s Mario Draghi talking down the currency at the Jackson Hole meeting increases. “We’ll do whatever it takes” Part 2?  We continue to call for growth slowing in the Eurozone (Q3 macro theme = #EuropeSlowing). We expect the Fed to raise rates ahead of the ECB and political and fiscal issues throughout the Eurozone to put downside support on the cross. This morning the ECB’s Vice President Vitor Constancio said the ECB will take further measures if it sees a significant risk to the outlook for inflation.

DAX

Down -5.8% week-over-week, the DAX index has been crushed along with its European peers, standing at a mere +2.5% year-to-date. If Germany with its exporting powerhouse (46% of GDP) alongside a weakened EUR/USD can't offset itself from the pack, who can?  Our #EuropeSlowing call includes the ECB’s inability to move inflation far from the zero bound.  

VOLATILITY

For much of the past 3.5 years, the VIX has been range-bound between 10-20, with occasional blips to 25 on front-month contracts. Yesterday’s close of 36.02 confirms a bullish phase transition for U.S. equity volatility that is unlikely to go away anytime soon. The move was eerily reminiscent of the 8/8/11 rip in the VIX that preceded several months of 30+ VIX closes. With the Fed gearing up to make a policy mistake in the coming months, could we be looking at a similar setup?

 

**Tune into The Macro Show with Hedgeye CEO Keith McCullough at 9:00AM ET - CLICK HERE

Asset Allocation

CASH 75% US EQUITIES 0%
INTL EQUITIES 0% COMMODITIES 0%
FIXED INCOME 25% INTL CURRENCIES 0%

Top Long Ideas

Company Ticker Sector Duration
MCD

One of the ways that McDonald's is going to take market share back is through one of the most popular items on its menu—the Egg McMuffin. "I honestly believe that if there is a silver bullet, it’s all day breakfast for McDonald’s," says Restaurants Sector Head Howard Penney. "And I do believe they’re going down that road and they will do it."

 

Penney adds that we’ll probably know more about that at the November analyst meeting and what the breakfast potential will be. There’s obviously a lot of things that go around MCD doing breakfast (e.g. shrinking other parts of the menu, etc).

PENN

"We continue to like Penn National Gaming here due to stable regional gaming trends, better than expected quarterly and annual earnings, and the Plainridge and Jamul contribution to PENN’s two-year growth story," writes Hedgeye Gaming, Lodging & Leisure Sector Head Todd Jordan. 

TLT

It was a very good week for those sitting behind the long-bond coming out of the FOMC minutes release on Wednesday. During a tumultuous 5-day stretch in which the S&P 500 fell over -5%, subscribers who followed our recommendation on TLT were sheltered from the market storm and gained almost +2%. Moreover, during the past month, TLT has gained +5.7% versus a -6.8% loss for the S&P 500 (a 1,200 basis point difference). In other words, it has paid handsomely to buck the consensus tide.

Three for the Road

TWEET OF THE DAY

5 Reasons Why the Fed Won’t Raise Interest Rates in 2015 https://app.hedgeye.com/insights/46004-5-reasons-why-the-fed-won-t-raise-interest-rates-in-2015 … via @HedgeyeDJ

@KeithMcCullough

QUOTE OF THE DAY

Keep your eyes on the stars and your feet on the ground.

Franklin D. Roosevelt

STAT OF THE DAY

New Home Sales in July were New Home Sales were +5.4% month-over-month and +26% year-over-year.


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