CAT | Official Denial & Pending Overshoot

“Never believe anything in politics until it has been officially denied.”  - Otto von Bismarck



Upshot: We see the potential stress at CAT Financial to be a downside catalyst for CAT shares in early 2016, and see commentary to the contrary as a sign that it is an internal concern. Deteriorating order trends still suggest that 2016 sales estimates need to move lower.  If those two catalysts play out, there is the potential for CAT shares to overshoot what we would see as a long-term fair value (perhaps around 60).  This management team seems frustrated, but after that 2016 reset, a new bullish narrative may emerge focused on structural cost reductions.



Relevant Prior Notes


Black Book: Feeling Used?



Three Takeaways


CAT’s report this morning is a mixed bag; that the shares could trade higher on it is probably a sign that sentiment is a bit down on the name.  We aren’t going to provide a tedious summary of the quarter since management did that at length on the earnings call.  There are lots of potential call-outs, like Resource Industries finally posting a negative margin.  But instead we will highlight our three takeaways.


  1. Hey, CAT Financial Is Fine Because Management Said So And They Always Nail It


Just a comment on CAT Financial in our captive finance business. It's a great business model. It's been proven through several ups and downs. Key metrics are in line with long-term averages despite weakness in a few very critical markets and it's healthy, well managed and risk is very much under control.”

        -  Doug Oberhelman 10/22/15


This management team has consistently been surprised by the extent of the downturn in resources-related capital spending.  CAT Financial didn’t exist during the last major cycle in resource-related capital equipment in the early 1980s, so we are not sure what “ups and downs” they mean.  After all, management finally referred to the downturn as a “super cycle” today.  We don’t think CAT Financial will do well in a super downcycle.  Who would?


If we were way off base in our expectation that CAT Financial is likely to become a drag in early 2016 (say, around the 4Q earnings report & 10-K), it probably wouldn’t have been specifically called out in the press release and earnings call.  We have detailed the specific exposures previously. In today’s report, we are interested by the odd combination of increased write-offs with a drop in allowance.  A bit of year-end assumption updating may well relieve our cognitive dissonance.


The current level of profitability seems to us unsustainable given the likely trend in residual values and the credit prospects of customers in North American Coal/Energy, Mining, and Emerging Markets.  We will need to wait for the 10-Q for the specifics.  


CAT | Official Denial & Pending Overshoot - CAT 1 10 22 15



Shouldn’t this be going the other way?

CAT | Official Denial & Pending Overshoot - CAT 2 10 22 15



If you don’t believe us that calling out the CAT Financial “model” (odd specificity) should be a concern, here are some cherry picked quotes.  They are well worth a read.


On Mining Downturn:  “We've added production capacity around trucks. We are staged to be the mining leader for decades to come. And I know there are lots of headlines out there that said mining is dead, not one more ounce of coal will ever be mined, iron ore will never come back, the world's going to stop spinning, it's over. Well, it's not over….”  -Douglas R. Oberhelman 9/24/2012


On Bucyrus:  “The Bucyrus acquisition, we need to finish that. We're almost done. It's been almost 3 years since we bought Bucyrus. Bucyrus brought to us greater stability during the downturn, we saw that in 2009 before we bought them, and we're seeing it again in 2013, plus it gives us greater growth opportunities -- more stability, greater growth.” – 3/4/14


On Brazil’s Economy: “I'm also optimistic in Brazil, although there's an election there this weekend, but both candidates, both parties are talking about reflating the economy and Brazil has always used infrastructure as a way to do that” – 10/23/14


On Oil Capital Spending: “…sustained basis certainly will take the really agitated top off of it, but there is still plenty of room for reinvestment.” – 10/23/14



Orders, Adjusted For Dealer Inventory, Still Trending Below 2016 Estimates


While it isn’t perfect, sales rates adjusted for changes in backlog and dealer stocks gives a decent sense of the run-rate top-line.  With the backlog dropping and estimated book-to-bill solidly below 1, we think 2016 sales estimates are still vulnerable.  Could sales come in closer to $40 billion next year? That appears increasingly plausible. It would be very hard to look at the orders in the quarter and conclude that the bottom is in.


CAT | Official Denial & Pending Overshoot - CAT 3 10 22 15


CAT | Official Denial & Pending Overshoot - CAT 4 10 22 15


CAT | Official Denial & Pending Overshoot - CAT 5 10 22 15



Not Happy With His Shareholders or The Street


In addition to the dig that “you may not as investors appreciate this in terms of dollars and cents” with respect to employee safety, there seemed general desire to avoid questions from the analyst community on the call.  The initial presentation cut off Q&A, and the call was not lengthened to accommodate questions.  What does a frustrated Oberhelman mean for CAT?  Probably nothing good for a leader who is laying-off employees and making tough choices.


Still, CAT management now has a more positive story to tell.  They do seem to be executing better on costs, and that matters.  The cost view into 2016 has more credibility with the trends below.


CAT | Official Denial & Pending Overshoot - CAT 6 10 22 15


Upshot:  We see the potential stress at CAT Financial to be a downside catalyst for CAT shares in early 2016.  We see commentary to the contrary as a sign that it is a concern in the C-suite.   Deteriorating order trends still suggest to us that 2016 sales estimates need to move lower.  If those two catalysts play out, there is the potential for CAT shares to overshoot what we would see as a long-term fair value (perhaps around 60).  This management team seems frustrated, but after a 2016 reset reflecting a weaker CAT Financial and current order rates, the groundwork is being laid for a new bullish narrative in the form of structural cost reductions.








McDonald’s (MCD) is on our Hedgeye Restaurants Best Ideas list as a LONG.


We have been saying that the third quarter of 2015 would be the inflection point for the MCD’s turnaround. After this print it appears that the heartache is over at McDonald’s, as this quarter marks the first good quarter the company has had in two years.


As it stands today, our estimates are for MCD to post a near record tying EPS in FY16 of $5.40-$5.60, with $6.00+ being a real possibility after this quarter. The potential of $6.00+ is dependent on how aggressive the company gets with any potential G&A cost cutting to be announced at the upcoming analyst meeting.


The combination of accelerating same-store sales, cost cutting and more efficient use of capital creates a scenario where MCD can easily reach $150 over the next 18 months.  This does not factor in any potential real estate transaction, which could make $150 even easier to achieve.  See the price matrix below for the assumptions around the $150 target.   



This quarter was astounding; McDonald’s proved once again that their brand is not dead. The operationally led turnaround is happening and the 3Q15 print was the inflection point. MCD reported total company revenue of $6.62bn roughly $210mm over consensus estimates of $6.41bn. Global same-store sales for the quarter increased +4.0% versus consensus estimates of +1.9%. The segment results were also very encouraging:

  • United States reported revenue of $2.19bn versus consensus of $2.10bn, same-store sales for the segment came in at +0.9% versus consensus estimates of -0.2%.
  • International Lead Markets reported revenue of $1.97bn versus consensus of $1.94bn, same-store sales for the segment came in at +4.6% versus consensus estimates of +3.4%.
  • High Growth Markets reported revenue of $1.65bn versus consensus of $1.61bn, same-store sales for the segment came in at +8.9% versus consensus estimates of +4.7%.
  • Foundational Markets reported revenue of $809.0mm versus consensus of $720.9mm, same-store sales for the segment came in at +6.1% versus consensus estimates of +1.4%.

Given the robust performance throughout the segments MCD reported 3Q15 EPS of $1.40 beating consensus estimates of $1.27 by $0.13.  The currency impact to 3Q15 was $0.17, as the USD continues to hold its strength against most foreign currencies.  




  • All day breakfast (ADB), although in the early days is performing well. In locations close to college campuses MCD is seeing a cult-ish type following from students where they are ordering breakfast during all day-parts. ADB received a 98% approval rating from franchisees.
  • National value: summer value deal was only temporary, the talks about this are intensifying with the franchisees and they are working towards a smart solution for both the business and customers.
  • Drive-thru’s are getting faster and more accurate.
  • Employee turnover coming down at company owned stores as they have already raised wages to near $10.
  • Net Simplification: adding breakfast does not add ingredient or equipment complexity since it is already there, operators are working around the complexity of doing it all day and it seems to be performing well.
  • France is maintaining share but given the tough environment in that country sales are still down slightly.
  • U.S. business was supported by the introduction of the new Buttermilk Crispy Chicken sandwich which exceeded internal expectations.
  • Australia continues to be the darling of the bunch, this being its 4th consecutive quarter of positive comps. They are running a great value message with the Loose Change Menu, and have turned on national advertising for Experience of the Future and management is encouraged by early results.
  • Russia and China (China SSS were up 26.8% in the quarter) both saw positive same-store sales in the quarter driven by a focus on food quality and value. Management is still predicting near term headwinds given the economic slowdown in China and hostility in Russia.


The road to $150 is not as farfetched as you might think. By 2017 MCD is going to be earning over $6.00 per share. There is still plenty of meat on the bone for Steve “everything is in play” Easterbrook to gnaw on in order to make MCD a modern progressive burger company.  The upside from a stock price perspective lies with the growth of All Day Breakfast, additional G&A cuts, national value offering implementation, reimaging of restaurants, commodity deflation, especially in beef and increased operational efficiencies, among others. In addition, the REIT is a potential driver of incremental value but not crucial to the long-term success of this call. With Steve Easterbrook at the helm we are confident this company will be better managed than it has been in a long time.












Please call or e-mail with any questions.


Howard Penney

Managing Director


Shayne Laidlaw




Cartoon of the Day: #Draghi Lays An Egg

Cartoon of the Day: #Draghi Lays An Egg - Draghi cartoon 10.22.2015


Q: How does Mario Draghi like his eggs?

A: "Over easy."

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The Consequences of Mario "Whatever It Takes" Draghi

The Consequences of Mario "Whatever It Takes" Draghi  - Draghi balloon cartoon 01.23.2015

Mario "Whatever It Takes" Draghi Full of Hot Air!

*  *  *


So... ECB head honcho Mario Draghi (more than) hinted that additional monetary stimulus is on its way. Like his central-planning cousin Janet just across the pond, Mario loves that monetary cowbell. The ECB governing council apparently had a “rich discussion” about what accommodative monetary instruments might be used in the not-too-distant-future.


On The Macro Show this morning, Hedgeye CEO Keith McCullough explained the ramifications of what more monetary easing means. Here are some highlights:

U.S. Dollar

The Consequences of Mario "Whatever It Takes" Draghi  - Dollar cartoon 03.09.2015

“The euro crept up a little bit yesterday to 1.15 versus the dollar, with everyone questioning that Draghi may not bring the thunder. That changed today. If it breaks 1.11, there’s going to be a mad rush to 1.05. If it gets to 1.05 on the euro you’re going to get 100-something potentially on the U.S. Dollar index. That is going to wreak havoc. Then you get the deflation dominoes.”


The Consequences of Mario "Whatever It Takes" Draghi  - Spain pain

“Will Draghi be able to keep Spain from crashing? We doubt it. Cowbell does not create economic growth if it’s via currency depreciation. What it actually does is devalue the purchasing values of the people. That means you need more to buy that loaf of bread."


The Consequences of Mario "Whatever It Takes" Draghi  - Oil cartoon 08.27.2015

“This is very deflationary. It is perverse, but it is what it is. Draghi devalues the euro, that takes the euro down, the dollar up, and oil and energy stocks down.”

Fed Interest Rate Decision

The Consequences of Mario "Whatever It Takes" Draghi  - Fed lady cartoon 06.25.2016

“The Fed is absolutely scared of its own shadow. The minute the market went down, they got scared. But now, the economic data is going down and the market is up. What does the Fed do on that? Well, they see the market react to a stronger dollar, via Draghi, and say to themselves we don’t have to tighten Draghi did that for us.”

What does it all mean?

The Consequences of Mario "Whatever It Takes" Draghi  - Growth cartoon 06.03.2015

“The Japanese taught us this, when you’ve got nothing else going on, the best security is government bonds. This is what happens when people don’t have economic growth, or hope, or anything to invest in. The core feature of a Long Bond is growth slowing.”


In other words, recent global developments are further confirmation of our firm's non-consensus macro theme #LowerForLonger and our contrarian bet on the Long Bond

UA | $1.00 vs. $4.00

Takeaway: Returns are declining, and will for at least 1-2 yrs. But those who can look out to $4.00 in EPS probably won’t – and shouldn’t -- care.

When a stock trades at 70x an underlying earnings stream that’s only growing 15%-20%, the cold, hard truth is that the ratio of ‘awesomeness-to-mediocrity’ needs to be off the charts in a given quarter to appease the market. For a day, at least. On today’s menu there was a bit too much mediocrity in the mix. 


Is there anything we heard that makes us question the long term growth potential of UA? Absolutely not. We think that it ultimately has between $3.50-$4.00 in earnings ($10bn revs at 12% margin). Importantly we think that UA is making the investments required to complete its transition from being a Great US Brand, to a Great Global Company. We actually don’t think it cares nearly as much as other companies in hitting a quarter, and for that we commend Plank & Co. That’s why there are some investors who own this name and will absolutely not sell it. They see a company going from $3.9bn in sales to $10bn, and earnings from just over a buck this year to $4.00 in five years’ time. 


But for some investors that don’t have Kevin Plank’s duration, the quarter matters.  And unfortunately, when looked at holistically, this was not as stellar a print as one might think in listening to all 5 Analysts who asked questions on the call congratulate management for doing its job.  


Revenue was on fire – coming in +29% yy. But Gross Profit was +27%, EBIT +21%, and EPS +17%. On top of that, the cash conversion cycle eroded by 15 days, the most in seven quarters. That’s due in part to higher footwear inventories, as the company scales up a fundamentally more complex business (lower margin and more capital intensive).  Most companies in Consumer Discretionary would be thrilled with this growth algorithm – but not those that trade at 70x earnings.


The reality is that this is a generational growth story that is almost always in a state of flux. All great stories are. We’re seeing rapid growth in businesses like footwear, that we would argue are responsible for arguably half of the company’s enterprise value – but just 15% of revenue. This is the most positive trend in the quarter full-stop. We’re looking at 61% growth in footwear, which is the fastest rate of growth since 3Q11, when the business was less than $200mm. In other words, it’s growing faster as it’s getting bigger, which goes against common logic. 


UA  |  $1.00 vs. $4.00 - UA 10 22 chart1

UA  |  $1.00 vs. $4.00 - UA 10 22 chart2

UA  |  $1.00 vs. $4.00 - UA 10 22 chart3

UA  |  $1.00 vs. $4.00 - UA 10 22 chart4




The title of our short presentation on VRX back in July 2014 was "Something New Under The Sun?".  It seems like a good title in retrospect. 

Click Here for the original deck


its hard to see a way out from here...

  • Claim edits likely go to "deny all" for anything come out of a pharmacy named in the media or associate with VRX
  • Extreme RX price inflation practices put a fast halt to prescription growth
  • Regulatory scrutiny does not end quickly
  • Yields are blowing out, debt and equity capital raises look out of reach, limiting buy-back potential and end to a debt-fueled acquisition binge and the "new pharmaceutical" model.
  • How quickly does anyone really think VRX can restart the R&D engines?






Please call or e-mail with any questions.


Thomas Tobin
Managing Director 



Andrew Freedman




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