Cartoon of the Day: Ackman's Valeant Effort

Cartoon of the Day: Ackman's Valeant Effort - Ackman cartoon 10.26.2015


Earlier this spring, controversial hedge fund manager Bill Ackman called Valeant Pharmaceuticals (VRX) “a very early-stage Berkshire [Hathaway].” Hmm. Fast forward to last week when an investment research firm compared the drugmaker to Enron. Shares have plunged 35% since and are down 57% from its August high. Last check, Ackman's Pershing Square Capital owns a 5.7% stake in VRX, constituting a whopping 19% of Pershing Square’s portfolio.




Our Healthcare analysts got the call right. On July 22, 2014, analyst Tom Tobin issued our Valeant Black Book laying out the short case and calling out what we considered to be an unsustainable business model.


CLICK HERE to access Tobin's prescient institutional research report on Valeant. If you’d like to learn more about our institutional research offerings please ping


call to action 

We turned positive on the lodging stocks as part of our September 22nd conference call/presentation and we remain so. Q3 earnings season probably won’t be littered with big earnings beats and raises but expectations are lower following a few pre-announcements and softer Smith Travel weekly numbers. Our focus is on where we are in the cycle – early enough for the stocks to outperform in our opinion – and the 2016 outlook. Our meeting planner survey suggests the group segment may outperform expectations and corporate negotiations could lead to a record setting 2016 rate gains in that segment.




Please see our detailed note here:




Wall Street Consensus Is Still Too High on Q3 GDP

Wall Street Consensus Is Still Too High on Q3 GDP - 10 26 2015 keith twitter economists


This is an important week for market watchers. On Wednesday, we’ll get an update on the Fed's interest rate policy. If you follow us, you already know our #LowerForLonger mantra all too well. In other words, we think it's highly unlikely our central planners will raise rates any time soon.


The next day we'll get a preliminary estimate on U.S. Q3 GDP. Another related theme here at Hedgeye is #GrowthSlowing, which espouses our increasingly dour outlook for both earnings and economic growth.


No surprise. Our Q3 GDP estimate is well below consensus.


As our macro analyst Darius Dale laid out in a recent conference call with subscribers, we’re calling for between 0.1% and 1.5% year-over-year Q3 GDP growth, versus the average 2.2% expected on Wall Street. It's worth noting that the consensus estimate has come down markedly throughout the year from above 3%. (We've consistently been at the low end of the range.) See the chart below.


Wall Street Consensus Is Still Too High on Q3 GDP - 10 26 2015 GDP estimate


We’re obviously in the #SlowerForLonger camp. Our forward-looking outlook for lackluster U.S. growth hinges on an increasingly strong dollar, bearish demographic trends and deflation.


Let’s be clear. We’ve got plenty of long-short ideas on how to play the evolving macro landscape. But investors that don’t should watch out.  


Wall Street Consensus Is Still Too High on Q3 GDP - Dove cartoon 0325.2015 


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.   



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 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




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



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.



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.



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. 






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.



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.




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.





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.




Please call or e-mail with any questions.


Howard Penney

Managing Director


Shayne Laidlaw





the macro show

what smart investors watch to win

Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.