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HAIN | SOMETHING NEW UNDER THE SUN?

Hain Celestial (HAIN) is on the Hedgeye Consumer Staples Best Ideas list as a SHORT.

 

It might be a stretch to draw similarities between Valeant (VRX) and HAIN, but we see some very eerie similarities relative to their respective industries.  The centerpiece of the SHORT call on both companies is focused on that fact that roll-up models carry big risks and rarely work over the long run.   

 

Our Healthcare team used the following quote when they wrote the SHORT presentation on VRX last summer:

“That which has been is that which will be, and that which has been done is that which will be done. So there is nothing new under the sun.” -Ecclesiastes 1:9

 

The SHORT story was centered on Valeant operating an unsustainable business model of “serial acquisitions and underinvestment, fueled by debt that will continue to lead to deterioration in the ongoing business.”  While the VRX story is just now coming to light and some smart money owns the name, there are now some very serious questions being asked about the company’s business model. 

 

In our view, HAIN is essentially no different.  HAIN is operating an unsustainable business model of serial acquisitions and underinvestment in its brands that will continue to lead to deterioration in the ongoing business.  In addition, the recently acquired businesses carry lower margins and overall returns.  One difference would be that HAIN’s balance sheet is not overly leveraged.

 

Like VRX trying to change the pharmaceutical business model, HAIN is trying to redefine how a typical food manufacturer operates a traditional business and that carries significant unquantifiable risks.  These risks will ultimately lead to the company trading at a discounted multiple over time.   

 

COMPANY GROWTH STRATEGIES

In the case of VRX, the company purchases innovation through serial acquisitions, exchanging R&D costs for interest payments and integration and restructuring costs (R&D spending at acquired companies is dramatically reduced).  In the case of HAIN, HAIN purchases “new brands” through serial acquisitions; exchanging G&A costs for interest payments (higher share count) and integration / restructuring costs (G&A spending is nearly eliminated at acquired companies over 12 months following the acquisition.)  HAIN further complicates its strategy by diversifying into new “organic” categories in which they are not part of the core competency of the company.    

 

THE RISKS

The short case for Valeant’s “new model” carries new and underappreciated risks.  We now know what some of those unappreciated risks are for VRX.  For HAIN, the street is just learning about some of the underappreciated risks.  In our last note on HAIN, we outlined one of those risks that we see as being underappreciated by the market – outsourcing key brand related functions.    

   

One of our biggest issues with HAIN is the secular decline in gross margins.  As the environment for “better-for-you” products in the U.S. gets more competitive, HAIN will not be able to defend brands or market position.  To that end HAIN, like VRX, does not invest much in R&D.  In FY2015, HAIN incurred approximately $10.3 million in company-sponsored (less than 0.5% of sales) in R&D, up only from $10.0 million in 2014.  Given how competitive this market is, spending 50% less on R&D than their competitors, is a long term issue for the company.  In addition, HAIN like all other consumer staples companies does not report the spending incurred by co-packers and suppliers on R&D, which does benefit the company.  That being said, outsourcing a critical function like R&D is an unquantifiable business risk. 

 

As we see it, the only weapon the company has to defend itself from a secular decline in gross margins is to make massive cuts in G&A.  Cutting G&A is never a long term winning proposition, and cutting too deep can put the long-term business model at risk.  In 4Q15, it looks as if they are cutting into the muscle of the company.  With the current G&A cuts announced for 2016, HAIN is now taking a big risk with their most important distribution channel. 

 

In 4Q15, HAIN announced that they were moving their natural channel sales/merchandising team to Advantage Sales & Marketing to “drive SG&A productivity.” Advantage is a third party national sales and marketing company that works with many companies within the consumer packaged goods space.

 

This is just the latest move by HAIN to reduce costs, saving them roughly 20-25% per year. Advantage is used by some of the big players to supplement their sales and marketing in the natural & organic channel, specifically on slower moving sku’s. The problem with HAIN’s use of this company is its sole dependence on it, as they said they moved their entire natural channel merchandising team to Advantage.

 

Transferring the entire operation out of HAIN is strategically a very risky idea and could lead to a loss of brand expertise at the company.  HAIN will effectively go from managing their brands first hand to having a third party manage them, depending on how their contract is structured (dedicated resources or not) will be a pivotal factor.  The biggest advantage of an internal sales force is, share of mind, you want your employees pitching your products. How do you know the third party will be representing your brands in the best light? 

 

These risks will only be known over time as selected brands begin to show slowing organic growth.    Unfortunately, the street will never know that until it is too late, because the company lives in a culture of no bad news and does not disclose key metrics that allows investors to understand how the business is truly performing.  Knowing they have something to hide, management has never consistently given the street historical context on:

  • Organic sales growth by segment
  • Non-organic sales growth by segment
  • Volume growth by segment
  • Price/mix by segment
  • Shipment vs consumption timing
  • Quarterly tone of business by region

 

Getting past the obvious similarities of roll up stories, HAIN is overvalued on its own merits.  Nearly 40% of the operating profits of its UK business come from private label brands.  In addition, most of the owned brands are not “organic” yet the company trades at a premium multiple relative to other mature food manufactures and/or private label business.

 

Please call or e-mail with any questions.

 

Howard Penney

Managing Director

 

Shayne Laidlaw

Analyst

 

    


NHS | Not What We Expected

Takeaway: New Home Sales bombed in Sept for reasons still unclear. That said, today's NHS print seems at odds with the preponderance of other data.

Our Hedgeye Housing Compendium table (below) aspires to present the state of the housing market in a visually-friendly format that takes about 30 seconds to consume.

 

NHS | Not What We Expected - Compendium 102615

 

Today’s Focus: New Home Sales for September

 

Well that wasn’t quite what we were expecting. 

 

New Home Sales declined -11.5% MoM in September and decelerated to +2% YoY – marking the lowest level of sales in 10 months and well off the +20% year-over-year pace of growth averaged YTD.  

 

Given the discrete pull forward in purchase demand (see 1st chart below) to close out September ahead of the impending TRID regulatory change on October 3rd, our expectation was for that bolus of demand to positively impact the September NHS and PHS figures and subsequently drag on the reported October data as the impact reversed. 


So, what happened?  In short, it’s unclear.  


What we do know is that the MBA & HMI (Builder Confidence) Surveys are telling a story antithetical to the NHS data and there are only a few roads available to reconcile the data.  

 

The MBA data is wrong, the NHS data is distorted, the preponderance of the pull forward occurred in the 90% of the housing market that is existing sales or some combination.  

 

We'll get some additional clarity alongside the release of September PHS data on Thursday. Below is some simple forensics on the NHS data along with some common sense speculation:

 

The preliminary Monthly New Home Sales data are derived from the Census Bureau’s Survey of Construction ( SOF) and are imputed based on the issuance of permits.  In other words, it’s a derived measure with significant standard error and not some direct count of contract signings.  Further, NHS carry the largest revision of any resi construction related series - a reality which stems from the fact that the count is based on permit issuance and many homes have a sales contract prior to a permit being issued.  Thus, if the apparent surge in late September activity occurred in the pre-permit phase, the impact would largely go un-captured by the preliminary survey calculation.  In that case, the Oct/Nov releases would likely carry positive revisions. 

 

In anyt case, definitely a soft print for NHS but given the regulatory noise and marked divergence from the MBA and HMI data, we’re content to wait for the PHS river card for confirming/disconfirming evidence on the underlying state of demand and any TRID related impacts.   

 

 

NHS | Not What We Expected - Purchase YoY

 

NHS | Not What We Expected - HMI LT

 

NHS | Not What We Expected - NHS Units   YoY TTM

 

NHS | Not What We Expected - NHS NHS vs SF Starts

 

NHS | Not What We Expected - NHS EHS to NHS ratio

 

NHS | Not What We Expected - NHS Inventory

 

NHS | Not What We Expected - NHS LT 

 

 

 

 

Joshua Steiner, CFA

 

Christian B. Drake

 


BLMN | HOW BAD IS BAD? ASK THE STEAK TRACKER

Takeaway: Adding it to the SHORT bench

It’s clear to us, and we suspect many others, that BLMN is going to have a bad 3Q15.  Given that the stock is down 28% year-to-date, we also suspect that the company will not recover from the 3Q15 miss and it will translate into a disastrous year.  If the fundamentals unfold the way it looks like they will, the company is going to need to revisit the need for a major restructuring.

 

WHAT NEEDS TO HAPPEN

BLMN needs to sell off non-core assets and focus on the core concept, Outback Steakhouse.  Looking at the same-store sales performance of Bonefish and Carrabba’s below, it’s clear that these concepts are in a secular decline and need to undertake a new path, under new ownership.  Management constantly reminds investors that “we remain disciplined stewards of capital as we focus on delivering on our long-term goals and driving shareholder value.”  Despite this, we believe that multi-branded casual dining companies are inefficient with capital, no matter what management says. 

 

This means reprioritizing their investments as appropriate. For now, they should focus their investments on international opportunities, the successful Outback relocation initiative, new units at Outback and Fleming's and the remodel program that will keep assets up-to-date.

 

WHAT TO EXPECT IN THE QUARTER

The company is scheduled to release earnings on November 3rd before the market opens.  As we see it, for 3Q15, BLMN will post flat EPS year-over-year of $0.10 for the quarter vs consensus at $0.14.  For full year 2015, we see estimates coming down to $1.20 versus consensus at $1.27.

 

For 3Q15 we see the Outback concept missing same-store sale estimates by 370bps.  In addition, Bonefish and Carrabba’s will also miss by 170bps and 210bps, respectively.   In 2Q15, management updated full-year comp sales guidance from “at least 1.5%” to “approximately 1.5%.” At the time, the lowered expectation was due to lower sales expectations at Bonefish. 

BLMN | HOW BAD IS BAD? ASK THE STEAK TRACKER - CHART 1

BLMN | HOW BAD IS BAD? ASK THE STEAK TRACKER - CHART 2

BLMN | HOW BAD IS BAD? ASK THE STEAK TRACKER - CHART 3

 

 

Needless to say the disappointing same-store sales will lead to disappointing margins.  We suspect that the biggest deleverage relative to expectations will come from the Labor and Other expense lines.

  

On the positive side, management will likely lower expectations for commodity inflation.  As of 2Q15, management expected commodity inflation to be between 3.5% and 4% down from 4% to 6% at the beginning of the year.

 

VALUATION

The stock has a very low value relative to its peers, but low is not always cheap. BLMN, currently trading at 6.8x EV / NTM EBITDA could compress slightly from here. Where we believe the real price drop will come from is a decline in EBITDA. We are currently projecting them to have total EBITDA in 2015 in the $445mm to $455mm range. Looking out into 2016 we are not expecting it to increase in any meaningful way, leading us to our bearish take on the name. Below is chart of EV / NTM EBITDA, showing little upside, with a reasonable amount of realistic downside.

BLMN | HOW BAD IS BAD? ASK THE STEAK TRACKER - CHART 4

 

MACRO MONITOR – STEAK TRACKER

For those of you who were not able to read our first note using the Macro Monitor, please refer to the link HERE. The macroeconomic data sets in the monitor allow us to pin point data that is relevant to the company and compare it to actual and projected performance. Economic data such as CPI, PPI, PCE, etc, is reported on a monthly basis, allowing us to get an intra-quarter read on the companies trends.

 

We are naming this the “Steak Tracker”, right now it consists of three very relevant employment and CPI data sets that have given a reliable read into the trends of Outback Steakhouse. The first is Men Employment 55-64 YOA, we view this age group as a major consumer of steak at restaurants. Secondly, CPI – uncooked beef steaks, and lastly CPI – beef and veal have been great barometers for Outback Steakhouse SSS trends.

BLMN | HOW BAD IS BAD? ASK THE STEAK TRACKER - CHART 5

BLMN | HOW BAD IS BAD? ASK THE STEAK TRACKER - CHART 6

BLMN | HOW BAD IS BAD? ASK THE STEAK TRACKER - CHART 7

 

As you can see all three of these are trending downwards. These trends, coupled with our fundamental analysis of the troubles this company is facing lead us to our BEARISH thesis, and with that we are adding it to the SHORT bench.

 

The stock is cheap and could get cheaper!

 

Additionally, we are also going to be taking Cracker Barrel (CBRL) off of the SHORT Bench.

 

BLMN | HOW BAD IS BAD? ASK THE STEAK TRACKER - CHART 8

 

Please call or e-mail with any questions.

 

Howard Penney

Managing Director

 

Shayne Laidlaw

Analyst

 

 

 


Daily Trading Ranges

20 Proprietary Risk Ranges

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Emerging Markets? #Crashing

Emerging Markets? #Crashing - China crash cartoon 08.25.2015 large

 

In a note to subscribers this morning, Hedgeye CEO Keith McCullough warned investors about the underappreciated risks embedded in emerging market debt.

 

“Emerging Markets didn’t like the Euro Devaluation last week, the EM MSCI Index closed -0.8% on the week. Reminder: there’s a $9T USD denominated debt #bubble that deflates on these tightening events (see our Q4 Macro Themes deck). Yes, ECB President Mario Draghi ramping USD is deflationary – ask Oil down -6.3% last week, or Energy Stocks (XLE -1.4%).”

 

Emerging Markets? #Crashing - em debt

 

Take a look at this slide from our Q4 Macro deck on emerging market debt .

 

Click to enlarge the image below:

Emerging Markets? #Crashing - macro deck usd

 

We see #deflation and the popping of over-inflated asset bubbles everywhere. That's why #Crashing is one of our Q4 Macro themes.

 

But we'll let you be the judge of the evolving trend playing out in emerging markets...

 

Emerging Markets? #Crashing - EM index 

 

*If you’d like to learn more about our institutional research offerings or obtain a copy of our Macro Themes deck please ping sales@hedgeye.com.

 

 


UPDATE: Hedgeye Energy Analyst Kevin Kaiser Reiterates His Short Case on Kinder Morgan | $KMI

In case you missed it, Kinder Morgan (KMI) is back in our crosshairs after posting underwhelming 3Q15 results, reflecting just how overvalued this name is. For the record, KMI remains a capital intensive, cyclical conglomerate with low-to-no growth and an over-levered balance sheet. 

 

UPDATE: Hedgeye Energy Analyst Kevin Kaiser Reiterates His Short Case on Kinder Morgan | $KMI - z ff

 

In Kaiser’s opinion, the MLP “go-go” days of valuing this company based upon its dividend/distribution are behind us. He sees no reason why fair value for this company shouldn’t be in the range of 9x-10x current EV/EBITDA, or $10-$13 per share suggesting over 55% downside.

 

UPDATE: Hedgeye Energy Analyst Kevin Kaiser Reiterates His Short Case on Kinder Morgan | $KMI - z kmi

 

UPDATE: Hedgeye Energy Analyst Kevin Kaiser Reiterates His Short Case on Kinder Morgan | $KMI - z 77

 

In its conference call last week, Kinder Morgan reduced its 2016 dividend growth guidance to +6%-10% from 10%+ through 2020 and offered new commentary that management has found a new “alternative source” of equity capital.

 

Bottom line: Whether it’s Rich Kinder himself, or other avenues, investors should be very wary of any new financing vehicle options that may be introduced as the ultimate “Hail Mary” to salvage this broken model.

 

*If you are interested in learning more about Kaiser’s research and how you can subscribe, or any of our other institutional research offerings, please send an email to sales@hedgeye.com


MONDAY MORNING RISK MONITOR | BRAZIL & CHINA

Takeaway: Brazil burns while China goes back to the Central Bank well one more time. Chinese GDP growth dovetails with Brazilian Sov CDS at 455 bps.

Key Takeaway:

Brazil appears to be coming apart at the seams. Sovereign CDS have widened to +455 bps, up another +14 bps last week. The move is remarkable not just because of its speed and magnitude (swaps have doubled since June), but also because not much else in EM following suit. While most of EM was widening from the summer through the early Fall, the trend over the last ~4wks has been tightening, whereas Brazil continues to widen.  

More broadly, most of our heatmap below has shifted from red to green based on the latest data. One broader theme underpinning the move is the central bank action from China last week. The positive reaction came despite the country's third quarter GDP coming in at 6.9%, the slowest rate since the financial crisis. Chinese slowing continues to be a point of concern for us, and we advise caution against relying on central-bank-stimulated optimism.

MONDAY MORNING RISK MONITOR | BRAZIL & CHINA - pinocchio

 

Current Ideas:

MONDAY MORNING RISK MONITOR | BRAZIL & CHINA - RM19

 

Financial Risk Monitor Summary

• Short-term(WoW): Positive / 6 of 12 improved / 1 out of 12 worsened / 5 of 12 unchanged
• Intermediate-term(WoW): Positive / 7 of 12 improved / 2 out of 12 worsened / 3 of 12 unchanged
• Long-term(WoW): Negative / 2 of 12 improved / 2 out of 12 worsened / 8 of 12 unchanged

MONDAY MORNING RISK MONITOR | BRAZIL & CHINA - RM15

 

1. U.S. Financial CDS – Swaps tightened for 21 out of 27 domestic financial institutions. CDS for Genworth financial tightened the most, by -55 bps to 577, while CDS for MBIA widened the most, by +60 bps to 752.

Tightened the most WoW: MMC, HIG, AIG
Widened the most/ tightened the least WoW: MBI, AGO, SLM
Tightened the most WoW: ALL, MMC, ACE
Widened the most MoM: LNC, GNW, MBI

MONDAY MORNING RISK MONITOR | BRAZIL & CHINA - RM1

 

2. European Financial CDS – Swaps mostly tightened in Europe last week. Likely aiding the decrease in risk perception was a better than expected reading from the EU's PMI composite flash. Additionally, as expected, the ECB signaled no rate changes at its October policy meeting.

MONDAY MORNING RISK MONITOR | BRAZIL & CHINA - RM2

 

3. Asian Financial CDS – CDS for Chinese banks tightened following the PBOC's cutting interest rates and the reserve-requirement ratio. The central bank's move followed Chinese third quarter GDP coming in below 7% in the October 18 reading. CDS in India also tightened significantly, between 10 and 17 bps.

MONDAY MORNING RISK MONITOR | BRAZIL & CHINA - RM17

 

4. Sovereign CDS – Sovereign Swaps mostly tightened over last week. Spanish and Italian sovereign swaps tightened the most, both by -13 bps.

MONDAY MORNING RISK MONITOR | BRAZIL & CHINA - RM18

 

MONDAY MORNING RISK MONITOR | BRAZIL & CHINA - RM3

 

MONDAY MORNING RISK MONITOR | BRAZIL & CHINA - RM4


5. Emerging Market Sovereign CDS – Brazilian CDS rose another +14 bps last week to 455 bps. For context, that's roughly a doubling since the summer. What's particularly notable is that the rest of the EM complex is actually trending tighter over the last few weeks.

MONDAY MORNING RISK MONITOR | BRAZIL & CHINA - RM16

MONDAY MORNING RISK MONITOR | BRAZIL & CHINA - RM20

6. High Yield (YTM) Monitor – High Yield rates fell 15 bps last week, ending the week at 7.39% versus 7.54% the prior week.

MONDAY MORNING RISK MONITOR | BRAZIL & CHINA - RM5

7. Leveraged Loan Index Monitor  – The Leveraged Loan Index rose 3.0 points last week, ending at 1849.

MONDAY MORNING RISK MONITOR | BRAZIL & CHINA - RM6

8. TED Spread Monitor  – The TED spread rose 1 basis point last week, ending the week at 32 bps this week versus last week’s print of 31 bps.

MONDAY MORNING RISK MONITOR | BRAZIL & CHINA - RM7

9. CRB Commodity Price Index – The CRB index fell -3.1%, ending the week at 194 versus 200 the prior week. As compared with the prior month, commodity prices have decreased -1.0%. We generally regard changes in commodity prices on the margin as having meaningful consumption implications.

MONDAY MORNING RISK MONITOR | BRAZIL & CHINA - RM8

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 widened by 2 bps to 12 bps.

MONDAY MORNING RISK MONITOR | BRAZIL & CHINA - RM9

11. Chinese Interbank Rate (Shifon Index) – The Shifon Index rose 1 basis point last week, ending the week at 1.91% versus last week’s print of 1.90%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.

MONDAY MORNING RISK MONITOR | BRAZIL & CHINA - RM10

12. Chinese Steel – Steel prices in China fell 0.9% last week, or 19 yuan/ton, to 2138 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity and, by extension, the health of the Chinese economy.

MONDAY MORNING RISK MONITOR | BRAZIL & CHINA - RM12

13. 2-10 Spread – Last week the 2-10 spread widened to 145 bps, 2 bps wider than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.

MONDAY MORNING RISK MONITOR | BRAZIL & CHINA - RM13

14. XLF Macro Quantitative Setup  – Our Macro team’s quantitative setup in the XLF shows 0.0% upside to TREND resistance and -5.9% downside to TRADE support.

MONDAY MORNING RISK MONITOR | BRAZIL & CHINA - RM14


Joshua Steiner, CFA



Jonathan Casteleyn, CFA, CMT


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