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CAG | GOING LONG

We are adding ConAgra Foods (CAG) to the Hedgeye Consumer Staples Best Ideas list as a LONG.

 

We don’t believe there is another Consumer Staples name that has been more of a chronic underperformer than CAG.  CAG has underperformed the S&P 500 by 38% of the last 20 years.  Over the past 5, 3 and 1 years the stock has outperformed the S&P 500, up 13%, 13% and 28%, respectively.  A significant part of the recent outperformance is due to the announcement of the new CEO and Jana taking a significant stake in the company. 

CAG | GOING LONG - CHART 1

 

ConAgra operates at margin levels well below the competition. A lot of this has to do with the businesses they are in, Private Label, Frozen and some lower end center-of-store items. But there is upside here. The new CEO spoke to upgrading the brands appearance through package design and improving the quality of the food, both of which will go a long way to helping the company attain higher price points at retail.

 

Recently, the disaster Ralcorp acquisition has finally led to Jana taking a significant position (with board representation).  In February 2015, the CAG Board announced that it hired Sean M. Connolly as its new CEO.  The new CEO’s resume and industry contacts are the right combination to reshape this company into a premier food company once again.  The alignment of the CEO, Board and activist shareholder forms a strong combination to take control of a struggling company to create significant upside for shareholders.   

 

ISSUES THE COMPANY IS FACING

  • Leveraged balance sheet Over the last five years, the company’s failed acquisition of Ralcorp and its generous dividend and share repurchase program has increased the debt on the balance sheet.
  • Too shareholder friendly The Company has paid out 78% of operating cash flow in dividends and share repurchases.
  • Under invested in the business – Over the last eight years the company has seen a steady decline in capital spending as a % of sales.  
  • Significantly lower margins than competition –the company has a lot of upside as they improve the quality of their portfolio over time.
  • Little international exposure – The Company has not invested in its international operations.

 

 

SHAREHOLDER MEETING SETS THE STAGE

Given the poor performance of this company over the last 20 years, another boiler plate restructuring will not give investors much confidence.  The company needs a bold program that will shake the company down to its core foundation.  The divestiture of the Ralcorp Private Brands business is just the beginning to this turnaround story. At the annual shareholders meeting on Friday, CEO Sean Connolly spoke briefly about the changes to come. He spoke to sweeping changes across the company from the structure to how they work.  He gave little details at the annual meeting, saying that the company plans to tell employees the details first, and if everything goes well, that will be by the end of this week.

 

Reading between the lines of his statements, big changes are coming.

 

He went on to say “will Illinois have a presence in our future, likely yes, will Omaha have a presence in our future, absolutely yes.” Illinois is where their consumer foods business is headquartered and Omaha is where the majority of their R&D and Quality operations are located. Sean went on to say, “Lamb Weston will continue to play an important role in our retail business.” Additionally, he spoke to accelerating the business internationally, (mainly China) where they serve predominately quick service restaurant chains.

 

Some of the key words from his comments at the annual meeting:

“Embrace bold change”

“Bold action”

“More focused company”

“Disciplined and focused”

“Pledged to be transparent”

“To stay competitive we must change”

 

HEDGEYE VIEW OF WHAT IS NEXT

We don’t know exactly what CAG will decide to do, except for the fact that the sale of the private brands business is well underway. In our opinion, there is little risk of this deal not going through given the relative quality of the business, and the distressed asset price that it will most likely go for. Rumored acquirers at this point include Treehouse (THS) and former owners Post Holdings (POST). Given POST’s balance sheet right now and other acquisitions there are still working on integrating, we view them as an unlikely acquirer. Treehouse looks to be in the lead from our vantage point as they would be able to reap a lot of synergy and scale benefit.

 

It’s clear that job cuts are coming next, how deep they will go is unknown. There are plenty of case studies from their fellow CPG companies that the consulting companies working with them know what works most effectively. Some form of zero-based budgeting (ZBB) will most likely be implemented as well.

 

Now, for the rest of the portfolio.

 

From Sean’s commentary during the shareholder meeting we would say for now, commercial foods is safe. But he left the door open for Naperville, Illinois being less than important to the company in the future. We believe there is going to be a pruning of the portfolio. Our suggestion would be to divest lower tier non-strategic brands from the portfolio to focus energy and capital on the most important ones. When looking at their portfolio there is not much to get excited about, center-of-store, frozen aisle type items. But there is still value there brands like Healthy Choice, Marie Callender’s, Hunt’s, Alexia, etc. still hold great value. This company clearly needs to focus on frozen and possibly expand within that aisle. Shed some can businesses like Ro Tel and Ranch Style that are not on-trend and aren’t top tier brands but could still hold some value to potential buyers.

CAG | GOING LONG - CHART 2

 

If management wanted to go big, they could get creative and do a Reverse Morris Trust (RMT). In this scenario we believe you would have to spin off the frozen assets or possibly the whole consumer foods segment and merge with a company like Pinnacle Foods (PF) or B&G Foods (BGS). This would be the most tax efficient and also the most transformative.

 

We believe the days of value destruction are over at CAG.  There is significant room for margin improvement at CAG and we believe that the combination of a new CEO with an aggressive core shareholder creates a stock we want to own in this market.  In the coming weeks we will expand on our thesis and where the biggest opportunities are. 

 

ANALYST RATINGS

Only 36% of the analysts have a buy on CAG! Seems as though everyone is waiting to see what happens next. Given the confidence we have on how the turnaround will unfold, the time to go LONG is now.

CAG | GOING LONG - CHART 3

 

SHORT INTEREST

Short interest is slightly above its five year average of 1.6%, currently at 1.8%.

CAG | GOING LONG - CHART 4

 

VALUATION

Below is the 5 year EV/NTM EBITDA chart. Although this company looks expensive, and has risen in valuation a lot over the last five years, it is still slightly undervalued compared to its peer set. We strongly believe that with the upcoming transformation this company will work into this valuation and beyond.

CAG | GOING LONG - CHART 5

 

BEST IDEAS LIST

CAG | GOING LONG - CHART 6

 

Please call or e-mail with any questions.

 

Howard Penney

Managing Director

 

Shayne Laidlaw

Analyst

 

 

 


CHART OF THE DAY: Bearish Market Beta (Eating Alpha, Alive)

Editor's Note: This is a brief excerpt and chart from today's Early Look written by Hedgeye CEO Keith McCullough. You should subscribe. We're pretty sure you'll thank us later.

 

...When money managers are forced to chase performance, stocks (and their style factors) accumulate a lot of consensus beta risk. Bearish market beta then starts to eat that alpha, alive.

 

If you look at the US Equity Style Factors that did the worst last week, they continue to look a lot like what we’ve been trying to keep you away from for the last 3 months:

 

  1. High Beta Stocks were down another -3.0% week-over-week (-15.5% in the last 3 months)
  2. Small Cap Stocks were down another -2.9% week-over-week (-13.9% in the last 3 months)

*Mean performance of the Top Quartile of SP500 performance vs. Bottom Quartile for the given style factor

 

CHART OF THE DAY: Bearish Market Beta (Eating Alpha, Alive) - z cod 09.28.15 chart


Rate Hiking

“Getting to the top is optional. Getting down is mandatory.”

-Ed Viesturs

 

Thinking about hiking? Some people love (d) the idea. You know, hiking into a global and local slow-down. Sounds like a great idea, until the stock market goes down on that news too.

 

Since Janet Yellen has no experience hiking interest rates, I thought I’d channel some of the wisdom of the only American to have reached the top of all 14 of the world’s greatest mountain peaks – Ed Viesturs.

 

The Fed should have been raising rates when US economic growth was accelerating (mid-2013 to late 2014). It missed its window to act objectively. The bond market hasn’t believed Yellen can raise rates (all year-long). And it doesn’t today either.

Rate Hiking - 3  yield Godot 07.27.2014

Back to the Global Macro Grind

 

After crashes across many macro markets continued last week, the IMF decided to fade Janet this morning and cut their Global Growth forecasts (again) for both 2015 and 2016.

 

#Crashes?

 

Yes, as in > 20% declines from the cycle/bubble peaks (there have been 3 major ones to climb going back to 1). While being long at the top of Biotech #Bubble was optional, getting drawn-down (-22%) since July’s peak was mandatory.

 

While the SP500 tried having a rate hike party on last Friday’s open, neither the Russell 2000 nor the Nasdaq were buying into the hype/hope, at all. They looked a lot more like Chinese, German, and Emerging Market stocks – not good.

 

Rate hike or no rate hike? Who cares – stocks are now going down on both.

 

In US stock market terms, here’s how the week-over-week looked within the context of the last 3months:

 

  1. SP500 -1.4% week-over-week, -8.1% in the last 3 months
  2. Russell 2000 -3.5% week-over-week, -12.5% in the last 3 months
  3. Nasdaq -2.9% week-over-week, -8.3% in the last 3 months
  4. Healthcare (XLV) -5.7% week-over-week, -12.1% in the last 3 months
  5. Basic Materials (XLB) -4.0% week-over-week, -18.9% in the last 3 months
  6. Utilities (XLU) +1.2% week-over-week, +2.9% in the last 3 months

 

That’s the first time that Healthcare (led by the Biotech crash) has been worst with Utilities first, in a long time. That’s mainly because everyone owns Healthcare now, and there was a lot of performance chasing to that relative strength top.

 

When money managers are forced to chase performance, stocks (and their style factors) accumulate a lot of consensus beta risk. Bearish market beta then starts to eat that alpha, alive.

 

If you look at the US Equity Style Factors that did the worst last week, they continue to look a lot like what we’ve been trying to keep you away from for the last 3 months:

 

  1. High Beta Stocks were down another -3.0% week-over-week (-15.5% in the last 3 months)
  2. Small Cap Stocks were down another -2.9% week-over-week (-13.9% in the last 3 months)

*Mean performance of the Top Quartile of SP500 performance vs. Bottom Quartile for the given style factor

 

The alternative to chasing “reflation” beta (Energy, Industrials, Basic Materials, etc.) and/or wicked high #Bubble beta (Social Tech, Biotech, Technical “Charts”, etc.) has been:

 

  1. Long-duration Bonds
  2. Low-Beta Stocks
  3. Stocks with liquidity (and low-beta) that look like bonds

 

Yes. I sound like I am repeating myself this morning. Because my competition, who has been long “reflation” and rates rising (Industrials and Financials) is repeating themselves too. And I’ll keep doing that until #LateCycle stops slowing.

 

Back to the concept that a rate hike “is just 25 basis points” and “we should just do it”, only people who don’t do Global Macro can be complacent about what an abrupt #StrongDollar move does during an economic slowdown (hint: it’s deflationary):

 

  1. Emerging Market Stocks (MSCI) were -5.3% last week, crashing -20.5% in the last 3 months
  2. Latin American Stocks (MSCI) were -8.6% last week, crashing -27.3% in the last 2 months
  3. UST 5yr-forward Break-Evens dropped -11bps to 1.09%, crashing -61bps in the last 3 months

 

With “inflation” expectations crashing, the Fed would definitely have to stretch way outside of its mandate/framework to reach for the top of those “rate hike” expectations in December.

 

On the growth front, you’re one more rate of change slowing US jobs report and/or a big Q3 GDP slowdown away from the bond market (and stock markets, worldwide) reminding you that taking rates down is mandatory as the cycle slows.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.07-2.21%

SPX 1
RUT 1122-1160
DAX 9
EUR/USD 1.10-1.14

Gold 1130-1160

 

Best of luck out there this week,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Rate Hiking - z cod 09.28.15 chart


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Cutting Global Forecasts

Client Talking Points

USD

A one-day move higher (off the lows) in USD and rates does not a credible rate hike make – no follow through so far on that with Janet Yen actually +0.2% vs USD this morning (Nikkei doesn’t like that, down another -1.3%).

RATES

Bond market doesn’t believe Yellen – neither does the growth data. 0.69% UST 2YR and 2.16% UST 10YR both remain bearish TREND signals for yields as Utilities (XLU) continue to breakout (+1.2% in a down tape last week, +2.9% in the last 3 months).

CRASHES

Biotech stocks (IBB) moved into crash mode on Friday (-22% from the July peak) joining China, Germany, Spain, Oil, Emerging markets, etc. in what is the most visible slow-moving-train-wreck Keith has seen in High Beta in his career. Latin American Stocks (MSCI) -27.3% in last 3 months.

 

**Tune into The Macro Show with special guest Hedgeye Restaurants and Consumer Staples analyst Howard Penney at 9:00AM ET - CLICK HERE

Asset Allocation

CASH 70% US EQUITIES 0%
INTL EQUITIES 0% COMMODITIES 7%
FIXED INCOME 23% INTL CURRENCIES 0%

Top Long Ideas

Company Ticker Sector Duration
MCD

McDonald’s clearly continues to be well-liked by our Restaurants research team and is a near perfect fit into our macro team’s current "style factor" preferences. This stock is high cap with a low-beta, coupled with a company turnaround story that is currently well underway. We believe this stock will do well through this tumultuous time in the market.

 

As previously mentioned, the company has all day breakfast starting on October 6. We anticipate this development as not only driving increased visits from existing customers, but also new customers that maybe don’t wake up early enough to get breakfast by 10:30am (or simply just people that enjoy eating breakfast items outside of the morning!)

PENN

As Sector Head Todd Jordan notes, "PENN should benefit from the release of state gaming figures over the next few weeks. Recall that August was weaker than many thought. While we predicted this particular slowdown, our model is showing a sharp September rebound.

 

September revenues should rebound and serve as a catalyst for the stock going into Q3 earnings. On the research side we have not altered our views of PENN’s long term growth story. We continue to see more upside from current price levels. 

TLT

Is the U.S. economy still showing signs of a cyclical slowdown? Yes.  If you, like us, remain skeptical on the said policy path from our omnipotent central planners, and you believe growth continues to slow, then we respectfully submit that you sit on your GLD and TLT allocations.

 

3 GDP comps are difficult. And, once the data comes out, we think expectations will be downwardly revised again. In other words, wait for yet another Fed punt on a 2015 hike.

Three for the Road

TWEET OF THE DAY

JAPAN: Nikkei draw-down continues, -1.3% overnight, -7.8% in the last month

@KeithMcCullough

QUOTE OF THE DAY

The winner's edge is not in a gifted birth, a high IQ, or in talent. The winner's edge is all in the attitude, not aptitude. Attitude is the criterion for success.

Dennis Waitley

STAT OF THE DAY

33 million Americans, 10.4% of the U.S. population went without health insurance for the entirety of 2014.


The Macro Show Replay | September 28, 2015

 


September 28, 2015

September 28, 2015 - Slide1

 

BULLISH TRENDS

September 28, 2015 - Slide2

September 28, 2015 - Slide3

September 28, 2015 - Slide4

 

 

BEARISH TRENDS

September 28, 2015 - Slide5

September 28, 2015 - Slide6

September 28, 2015 - Slide7

September 28, 2015 - Slide8

September 28, 2015 - Slide9

September 28, 2015 - Slide10

September 28, 2015 - Slide11


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