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Stock Report: Junk Bonds (JNK)

Takeaway: We added JNK to Investing Ideas on the short side on 10/8.

Stock Report: Junk Bonds (JNK) - z jnk 1

THE HEDGEYE EDGE

Our edge right now with High Yield Fixed Income is our macro team's continuing dissection of the cycle. Look no further than corporate activity YTD…

 

With a phase transition in volatility that has crushed buy-side performance and sent U.S. equities on a roller coaster ride over the last couple months, confidence in what has been a 6-year bull market is waning. Just 37% and 43% of S&P 500 companies recorded sequential acceleration in sales and earnings growth, respectively, in the latest quarter. Operating margins have already peaked.

 

That sounds like a slowdown.

 

Rather than experiencing organic growth, large companies are attempting to manufacture growth by buying back shares, sidelining capital investment projects, and acquiring other companies. 2015 will be a record year for M&A activity. The previous record? 2007...

 

From our perch, debt-financed buybacks at peak valuations, peak margins and new highs in corporate leverage does not equal long-term shareholder value creation. Buyback trends are a classic contra-indicator with activity peaking at the end of the cycle.

 

Bottom line: This kind of corporate activity in aggregate is just another late-cycle indicator. 

TIMESPAN

INTERMEDIATE TERM (TREND) (the next 3 months or more)

 

Our proprietary Growth, Inflation, Policy (GIP) model is signaling that Q3 GDP, on a year-over-year basis, faces very difficult comparisons (this year vs. last year) in Q3 and Q4 of this year. Our estimated range for GDP for Q3 is 0.1-1.5% which is still below consensus despite estimates that have been taken down by Central Bankers and consensus Wall Street.

 

If GDP prints in that range, forward-looking growth expectations will be downwardly revised as evidenced in bond yields going lower and credit spreads widening.

 

LONG-TERM (TAIL) (the next 3 years or less)


When the economic cycle begins to roll-over, a drawdown in the equity market manifests, volatility ensues, and credit spreads widen. There is a rotation into what is considered safer fixed income (TLT and EDV for example) at the expense of riskier borrowers (worse credits). The commonalities of a cyclical slowdown and secular headwinds are matching up to give us visibility into our #superlatecycle call which happens to be one of our top Q4 2015 Macro themes.

ONE-YEAR TRAILING CHART

Stock Report: Junk Bonds (JNK) - z jnk 2


Stock Report: Tiffany (TIF)

Takeaway: We added TIF to Investing Ideas on the short side on 10/5.

Stock Report: Tiffany (TIF) - z tif 1

THE HEDGEYE EDGE

If you’re looking for a U.S. Equity to play our macro team’s #LateCycle #SlowerForLonger bearish themes, here’s a name wrapped in a "Little Blue Box" just for you.

 

We all know Tiffany. Generally speaking, this is a structurally sound business. It is definitely not a ‘headed to zero’ short like we’d argue for a company like Wayfair (W). But stocks of good companies like Tiffany go down all the time, and we think TIF is headed lower.

 

Common perception seems to be that “just because TIF blew up earlier this year, it can’t blow up again.” We disagree. It actually blew up twice this year. And we think there will be another. We didn’t like TIF into the latest print, and we definitely don’t like it on the way out. The company lowered back half guidance, which we expected to see, but we’re not sure if $0.10 is enough off of 2H14’s $2.27 base. We’re inclined to think ‘no’.

 

The bigger tell for us will be how much consensus numbers come down for next year. They currently sit at $4.56. If the macro environment plays out like we believe, then we think we’re looking at a number closer to $4.00.

 

The problem here is that management is adjusting guidance based on what it sees at the time of the earnings report – not based on how the environment will likely deviate from what they see in front of them.

 

Also keep in mind that the company is at peak productivity of $3,500/ft (some less productive Apple stores – the highest s/sqft in retail -- do $3,500), peak Gross Margins, trough SG&A margins, peak diamond exposure (59% of units has a diamond, which is gross margin accretive), and only can grow square footage by 2-3% on its best day.

 

We have no doubts in the quality of the management team or brand name, but the reality is that there are no obvious margin levers to offset the declining growth profile in the business, especially amidst increased late cycle risks.

 

It is trading near a peak multiple (18.5x) on peak margins (21%), a peak earnings ($4.20E TTM and NTM) that isn’t growing, peak returns (18%), has the worst cash conversion cycle we’ve ever seen (490 days), while sentiment is sitting at all-time highs.

 

It’s feast or famine – if one of those metrics breaks, then they all do.  

ONE-YEAR TRAILING CHART

Stock Report: Tiffany (TIF) - z tif 2


Stock Report: Wayfair (W)

Takeaway: We added Wayfair to Investing Ideas on the short side on 10/2.

Stock Report: Wayfair (W) - z wayfair 1

THE HEDGEYE EDGE

Wayfair is one of those polarizing stocks in the investment community where there is plenty of love, plenty of hate, and not much in between. Use whatever emoji you want…we’ll stick to research, our investment process, and simple math. Those three things combined tell us that Wayfair is unlikely to earn money – ever.

 

With a market capitalization of $3.5bn (roughly on par with Restoration Hardware) we can be pretty certain that our view is not currently represented in the stock. While it might take a while, we think that Wayfair is ultimately headed to zero.

 

Let’s first respect the Bull case (it takes two to tango) and start with the positive. The speed at which W has achieved such strong brand equity in such a fragmented space (Home Furnishings) is incredibly impressive. It’s emerging as something of a ‘buyers agent’ for Home Goods the same way WMT and COST have done for their consumers. That buying power will be hard to compete with for anyone. Ad costs are coming down incrementally, and although we think they’re ultimately headed much higher, it should help margins over the near term (and the bulls know it).

 

To be clear – if this management team wants to, it could pull back on investment spending (bad long term move) and temporarily report a small profit. But when a company with 58x inventory turns flirts with profitability, the risk to the upside could be both dramatic and painful. There’s your short term risk. But to be clear, that’s the exact event we’d use to get even heavier on the short side.

 

This is a name where you keep selling Green.

 

Now for the Bear Case – the Hedgeye Bear Case. First off, Wayfair has considerably higher penetration in its TAM (total addressable market) than people believe. People – including Management, are using numbers like $200bn-$300bn as an addressable market. That’s just flat-out wrong.

 

We’ve done extensive research on this one, and when all is said and done, we think that the end market is no more than $30bn. To put that into context, it suggests that Wayfair has about 10% share of its market. That’s 2-3x the share of players like RH and IKEA. There’s absolutely no reason why this should be the case.

 

The primary reason is that Wayfair sells furniture and home goods. The purchasing process for a consumer durable like a set of bunk beds, for example, almost always includes in-store visits as well as online research. You get that at Williams-Sonoma, Restoration Hardware, and even Pier 1. But you can’t touch and feel the seven million items sold by Wayfair before you buy. In fact, our research suggests that W’s target consumer has a ‘blind buy’ threshold of around $750. That’s well below the prices listed for furniture sold on its websites.

 

Now…that only applies to furniture, but what about thinks like lamps, linens, and kitchen utensils? Yes, that’s where we think Wayfair will drive incremental volume. But how defendable is it when that product can also be bought online/in-store at Bed Bath & Beyond, Kohl’s and Target?

 

Overall, our work shows that the incremental customer is likely to be much more price sensitive, which not only challenges long term Gross Margin targets, but takes customer acquisition costs higher off a reprieve in 2015. We do think there’s 500bp upside in Order Margins over time, but we need to see 700bp to get Wayfair in the black.

 

Also, we previously thought an AMZN take-out was a safety net. That’s no longer the case. There’s little that Wayfair has that Amazon cannot build on its own. Heck, look at Etsy. That was also a rumored AMZN target. On October 8, AMZN announced a home-grown site that competes directly with ETSY. In this case, W is on its own to sink or swim.

 

Maybe Management realizes that with $11.2mm in insider sales since the stock hit all-time highs in mid-August, and $40mm since the lockup expiration at the end of March.

ONE-YEAR TRAILING CHART

Stock Report: Wayfair (W) - z wayfair 2


Early Look

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Retail Callouts (10/9): UA, NKE, Adibok, URBN, W, OSTK, WMT, RL, AMZN

Takeaway: UA’s Wisconsin deal another notch against NKE. Tough Sept for AMZN US? OSTK furniture @ 86% off. C-Suites getting younger.

UA - Under Armour signs 10yr deal to outfit University of Wisconsin.  Under prior Adidas deal, Wisconsin was getting $1.375mm in product and $800k in cash.  UA will provide $2.45mm in product and $4mm in cash annually.  Importantly, UA now has 3 of the 14 Big Ten teams (Maryland, Northwestern, Wisconsin).

(http://www.cbssports.com/collegefootball/eye-on-college-football/25331284/wisconsin-is-leaving-adidas-in-2016-for-10-year-deal-with-under-armour)

 

Wisconsin is just a drop in the bucket compared to what UA spent to lock down the Fighting Irish (UA - $10mm per year) and what Nike doled out for U of Michigan ($11.2mm per year), but there are a few interesting points we took from the deal…

1) Adidas is backing down meaningfully. The PR department at AdiBok was sure to throw in its public statement that it 'chose not to renew the deal'. Just like the company chose not to renew the deals with Michigan, Notre Dame, Tennessee, etc. By saying "chose not to renew" Adidas is saying "can not afford or get a positive ROI".

2) Obviously the team/league sponsorship hasn't worked in the US, but we're also skeptical about the efficacy of the stepped up endorsement spend on individual athletes where NKE especially, and UA to a lesser extent , already dominate. To cite one example -- Adi is spending $200mm on NBA MVP runner up James Harden, and is having a hard time getting the athlete to wear the brand in public.

3) UA now dominates the Chicagoland sports scene with partnership agreements inked with Northwestern, Notre Dame, and Wisconsin all of which have a big presence in the city. And the company owns the naming rights to the Cubs spring training facility and is one of the 5 legacy partners with the team. That's no coincidence given that the brand opened a 30k sq. ft. Brand House smack dab in the middle of Michigan Ave. Keep in mind that Chicago is the penultimate 'Jordan Town'. At least, it has been...

Retail Callouts (10/9): UA, NKE, Adibok, URBN, W, OSTK, WMT, RL, AMZN - 10 9 2015 chart1

 

URBN - Urban Outfitters asked some salaried employees to volunteer at a fulfillment center in Pennsylvania expecting a busy October. Company said hourly employees were willing to help, but were rejected to comply with labor laws. To URBN's credit, it's rare that people will work for free in any profession. But all-in, the request from URBN crosses the line.

(http://www.huffingtonpost.com/entry/urban-outfitters-free-labor-and-other-controversies_5616be4ae4b0e66ad4c6f1cc)

 

W, OSTK - Overstock.com is offering 16% off furniture to celebrate its 16th birthday. At face value, we thought "that doesn’t seem very steep, the regular discount is 40-50% on OSTK." But if you check out the website you see that it's the standard discount (which is currently 70%) plus an additional 16%. Basically, OSTK is selling furniture for 86% off. People don't look at OSTK as often as they should when analyzing Wayfair -- but they should.  This discounting is severe.

(http://www.furnituretoday.com/article/524541-overstockcom-observes-16th-birthday-16-furniture)

 

WMT - CFO Charles Holley to retire Dec. 31, 2015 after 20 years. Brett Biggs, 47, will succeed Holley. Now WMT has a 49 year old CEO and 47 year old CFO. The age trend for retail executives continues to head lower. Note that with Ralph Lauren's recent announcement, the average age of the C-Suite went from 61 to 49 years.

(http://news.walmart.com/news-archive/2015/10/09/walmart-appoints-brett-biggs-new-chief-financial-officer)

 

AMZN - Comps from ChannelAdvisor are out.  This is actually a reasonable underlying directional indicator for AMZN's business, as outlined by mapping out the 2-year run rate for each on a quarterly basis. The bad news, however, is that September slowed on both a 1 and 2 year basis.

Retail Callouts (10/9): UA, NKE, Adibok, URBN, W, OSTK, WMT, RL, AMZN - 10 9 2015 chart2

Retail Callouts (10/9): UA, NKE, Adibok, URBN, W, OSTK, WMT, RL, AMZN - 10 9 2015 chart3

 

Can Everlane Really Become the Next J.Crew?

(http://www.racked.com/2015/10/8/9442455/everlane-expansion?curator=MediaREDEF&ncid=newsltushpmg00000003)

 

Ikea to open a Jacksonville, FL store in 2017.  Store planned to be 294,000 SqFt.  This will be Ikea's 1st store in North Florida, and its 5th in the state.

(http://www.furnituretoday.com/article/524539-ikea-open-jacksonville-fla-store-2017)

 

WMT - Laura Phillips to become senior VP of sustainability.  Current VP, Manuel Gomez taking position as VP of e-commerce strategy for Walmart Mexico/Central America.

(http://www.retailingtoday.com/article/report-walmart-makes-change-sustainability-leadership)

 

UA -  Under Armour settles lawsuit around issue of new non voting stock to protect CEO Plank's control of the company.  The company issue additional compensation to the holders of Class C stock in the form of a dividend with a value of $59 million.

(http://footwearnews.com/2015/business/earnings/under-armour-lawsuit-settlement-stock-shareholders-161063/)

 

ASNA - Golden Gate discloses 9% stake in Ascena Retail Group

(http://wwd.com/retail-news/financial/golden-gate-9-stake-ascena-retail-group-10258423/)

 

ARO - Aeropostale Signs License Agreement With Himatsingka America For Home Textiles

(http://phx.corporate-ir.net/phoenix.zhtml?c=131103&p=irol-newsArticle&ID=2095591)

 


CHART OF THE DAY: Winter Is Coming For Global Growth

Editor's Note: Below is an excerpt and chart from today's Early Look written by Hedgeye Director of Research Daryl Jones. Click here for more information on how you become a subscriber to our decidedly non-consensus morning note.

 

"...the prevailing view of our Q4 theme presentation is that Winter Is Coming for global growth. As you can see in today's Chart of the Day, we remain 50% below Bloomberg consensus for global GDP growth."

 

CHART OF THE DAY: Winter Is Coming For Global Growth - z chart 55

 

 

 

 

 

 

the prevailing view of our Q4 theme presentation is that Winter is Coming for global growth.  As you can see in today's Chart of the Day, we remain 50% below Bloomberg consensus for global GDP growth.

Winter is Coming

“Now is the winter of our discontent.”

-Shakespeare

 

We held our big Q4 Macro themes call yesterday. No surprise, Keith put quite an entertaining spin on the presentation.  The introduction to the second section was a spoof of the popular HBO TV show, “Game of Thrones.” We renamed it “Game of Slowing” with each major economic region represented by a specific character from the show:

 

  • China / Emerging markets as Eddard Stark because Stark dies early and he did not come back;
  • Europe as Joffrey Targaryen because Joffrey does become King, but eventually it ends poorly for King Joffrey (and by extension European equity bulls);
  • Japan as John Snow, the bastard of global growth because Japanese growth continues to get worse (and worse); and finally
  • U.S. as Daenerys Targaryen, which represents the goldilocks potential of U.S. growth.

 

Winter is Coming - z hbo

 

Now, if you haven’t watched the show, the analogies may not mean as much to you. But suffice to say, the prevailing view of our Q4 theme presentation is that Winter is Coming for global growth.  As you can see in today's Chart of the Day, we remain 50% below Bloomberg consensus for global GDP growth.

 

Back to the Global Macro Grind...

 

Related to U.S. growth, my colleague Darius Dale wrote a follow up note to the themes presentation yesterday titled, “Risk Managing the Shift to #Quad3 – Especially in Energy.” So even though we were somewhat sympathetic to the idea that the U.S. economic outlook may have the potential for a better outcome as represented by the beautiful Daenerys Targaryen, the reality is that the U.S. is likely to be mired in a shift to Quad 3 based our models.

 

For those that haven’t been following Hedgeye as closely, Quad 3 occurs when growth slows as inflation accelerates.   Historically, the policy response in this scenario is that the central bankers are in a box because even though growth is clearly slowing, inflation is at, or surpassing their targets. Only time will tell whether the ensuing months play out like this, but one asset to stay focused on is oil.  As Darius writes:

 

“Since most investors are not positioned for energy to lead the market higher, we thought we’d offer our detailed thoughts on this developing risk. Specifically, at 7.3% of float, energy is the most heavily shorted sector in the S&P 500. That ratio is 297bps above the aggregate market and the next closest sector, consumer discretionary, is a distant -90bps behind. Indeed, investors are still very bearish on energy.

 

Why has energy lead the market higher over the past month (XLE +13.2% WoW and +7.1% MoM vs. +4.7% and +2.2% WoW and MoM, respectively, for the S&P 500)? Because of the ongoing shift to #Quad3 – economic growth slowing as reported inflation readings accelerate – and the dovish response we have gotten and may continue to receive from the Fed in the ensuing months.”

 

So, just as the decline of energy commodities and the total decimation of certain energy related equities like MLPs has hurt many on the long side, the appropriate debate to have now in your investment committees may well be whether you should be longer of energy into year-end.

 

On the topic of oil, WTI is above $50 per barrel for the first time this morning.  Adding to the bull case through year end is also the call out of Goldman this morning that the rally in oil is likely to reverse soon.  No surprise, we would recommend taking the other side of that call, especially in light of our expectation that the Fed will be more dovish than expected and thus the USD weaker.

 

Switching gears for a second to China, there is a noteworthy article from Bloomberg today emphasizing the frothiness.  Even as we joked with our #GameOfSlowing metaphor that Chinese economic growth may never come back, Chinese equity investors do seem to be voting that way with their dollars, flooding out of equities and into the corporate debt market.  

 

Over the last month, yields on top rated corporate five-year paper are down 79 basis points.  As a result, the spread over government securities is at 97 basis points, the narrowest since 2009.  To put this all in context, globally corporate yields are at almost two-year highs, so Chinese corporate yields are moving inversely to global yields.

 

Currently, default rates do remain low in China, so there is likely no reason for alarm just yet.  That said, credit default swaps (CDS), which are effectively insurance against corporate defaults, are also near two-year highs at around 135 basis points on average.  The fact that insurance against defaults is getting more expensive should be no surprise given the stretched valuation and, also, the fact that more than 15% of the companies listed in Shanghai lose money.

 

Historically, of course, defaults in China have remained low, but facts are facts even in centrally planned economies.  And as George Martin wrote in “A Game of Thrones”:

 

“Most men would rather deny a hard truth than face it.”

 

Indeed.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.98-2.12%

SPX 1 

VIX 15.94-28.98
USD 95.16-96.16
Oil (WTI) 46.39-50.25 

Gold 1130-1160

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

Winter is Coming - z chart 55


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