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October 27, 2015

October 27, 2015 - Slide1

 

BULLISH TRENDS

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BEARISH TRENDS

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October 27, 2015 - Slide11

 


TWTR: Thoughts into the Print (3Q15)

Takeaway: Tricky setup with a lot of moving parts. We remain short since TWTR will eventually need to rebase 2016 expectations, question is when.

KEY POINTS

  1. UPSIDE ALREADY EXPECTED? TWTR preannounced 3Q15 revenues to come in at or above the high end of guidance, so now a 4Q guidance beat may also be the expectation.  That will be a challenge since consensus is assuming no decay in y/y ad revenue growth from 3Q to 4Q, which means TWTR can't afford any slippage on either engagements or CPE (despite slowing user growth and its first positive CPE comp from 4Q14, respectively).  While acquisition revenue could help fill the void, consensus already appears to be baking that in with 4Q data licensing revenues ramping to $63M by 4Q (vs. $50M reported in 2Q).  However, TWTR could produce upside on MAUs following tepid user growth comments on its last call.  
  2. BUT TRICKY SETUP: We’re not sure what matters more on this print: the release or how the new C-suite addresses the street regarding the longer-term story.  That’s really tough to gauge since we’re not sure what Dorsey could offer to breathe life back into this story; but he may not need much on muted sentiment.  But we also suspect that Dorsey knows that 2016 expectations need to be rebased, and doubt he is willing to risk another blow up similar to the 1Q15 release.  That said, we suspect the new c-suite may try to manage expectations before it releases 2016 guidance on the next print (also less incentive to guide high for 4Q15).
  3. WHAT WE’RE KEYING IN ON: Ad engagements and CPE; the wider the divergence between the two, the more TWTR is increasing ad load.  We suspect TWTR's surging ad load is what is causing its softening user growth metrics, and mgmt's ongoing attempts to appease street revenue expectations has led to a heighted level of cumulativer churn that will ultimately cap its long term upside (see 1st note below).  Put another way, TWTR has been chasing short-term upside at the expense of long-term damage to its model; we're ultimately trying to figure out whether that may change under the new regime.  

 

TWTR: Thoughts into the Print (3Q15) - TWTR   Ad MAU vs. CPE 3Q15

TWTR: Thoughts into the Print (3Q15) - TWTR   4Q15 Ad Rev Scen

TWTR: Thoughts into the Print (3Q15) - TWTR   FC Ad Rev 2Q15

 

See notes below for supporting analysis on TWTR's user retention issues and monetization strategy.  Let us know if you have any questions, or would like to discuss further.  

 

 

Hesham Shaaban, CFA


@HedgeyeInternet 

 

 

TWTR: The Crossroads  (User Survey: n=7,500)
08/25/15 07:48 AM EDT
[click here

 

TWTR: What the Street is Missing
05/19/14 09:09 AM EDT
[click here]


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.

 

Ouch.

 

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 sales@hedgeye.com.


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Q3 LODGING EARNINGS PREVIEW

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.

 

RELEVANT TICKERS: H, HLT, HOT, HST, MAR, WYN 

 

Please see our detailed note here: http://docs.hedgeye.com/HE_Lodging_Q3_Earnings_Preview_10.26.15.pdf

 

 

 


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 | 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

 

    


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