We thought the focus of the (embarassing) GOP debate last night in Colorado was supposed to be on the candidates, not the (shameless) moderators. CNBC owes an apology.
Takeaway: El Nino correlates to weather, and weather correlates to DE. But the direction is not so obvious. We would view fleet dynamics as more important. Volatility in weather is more of a risk to our short thesis than a further support of it.
Replay & Materials From Ag Equipment Black Book:
Short DE Best Ideas Addition (5/22/2015)
Where To From Here? (9/21/2015)
This is just a quick response to a bearish El Nino narrative circling farm equipment this week, in particular DE and AGCO. For us, what is likely to matter most to farm equipment sales are fleet demographics and farm income trends. We think we are in a period were the former is most critical. Ongoing commentary from dealers and the advance orders support our more negative view.
However, inflections in El Nino do appear to correspond well to inflections in DE’s relative performance. Over the past decade, a short sample period for industrial equipment, the DE-El Nino correlation has been negative. However, a longer series shows that the relationship with El Nino is not particularly consistent or, most likely, useful. Unfortunately for DE, volatile weather cannot undo years of above trend farm equipment investment, aggressive pricing actions by inventory sodded competitors, or decrease stocks of used equipment.
Upshot: El Nino correlates to weather, and weather correlates to DE. But the direction is not so obvious. We would view fleet dynamics as more important. Volatility in weather is more of a risk to our short thesis than a further support of it.
Our macro call here at Hedgeye remains #LowerForLonger (Rates) due to #SlowerForLonger (Growth). Witness today's U.S. 1.5% GDP report. The answer to Hedgeye CEO Keith McCullough's question below? Seems pretty self-evident.
"When GDP gets cut by more than 50% quarter-over-quarter, the Fed should "raise rates", right?"
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Takeaway: The split is on track for February, but now with better leadership and significant identified restructuring opportunities. We think that MTW is one of the most undervalued and least understood names in the sector.
We think that the departure of Glenn Tellock is a positive for MTW and that Hubertus Muehlhaeuser seems a very promising segment leader. The restructuring opportunities in the 3Q release suggest a substantial opportunity to improve operations, which is not that surprising given a lack of prior operational attention. The 3Q preannouncement was somewhat misleading, in our view, since it provided little context on weaker Crane results that we now know were driven heavily by delayed VPC shipments. The planned split was defended robustly on the call, including the point that an investment grade credit rating for either segment is not needed. In all, we continue to think the split will unlock substantial value and that MTW is one of the most undervalued and misunderstood companies in the sector.
Preannouncement Head Fake: MTW’s preannounced a GAAP number, which we thought inappropriate given the separation costs. Today, we learned that MTW had $10.4 million in costs associated with restructuring and separation, as well as a “ballpark” $15 million hit from delayed shipments of newly introduced VPC cranes (now corrected). Backing out those items, MTW generated an estimated operating income of ~$68 million vs. $83 million in the year ago period. While down, it is hardly as catastrophic as headlines suggested. Those items should also have been disclosed in the preannouncement.
Split Defended Strongly: Apparently, no one on the Board cares if Cranes is investment grade, or if it has a fairly small valuation and profitability. We agree that the split is a great value-unlocking opportunity; as we see it, the Crane segment has a ‘negative’ valuation at present. We also think that the Cranes business is less broken than some believe (see below).
Tellock Out Is A Positive: It seems clear that Glenn Tellock was let go by the Board. Hubertus Muehlhaeuser, the new head of the Foodservice business, sounded very strong on the earnings call this morning. That is a significant upgrade from his introduction on the last call, when Tellock didn’t given him much of an introduction. Hubertus’s presentation was detail oriented and he handled the Q&A effectively. As we see it, Tellock did not appreciate activist meddling and never seemed on board with the split.
Restructuring Guidance Quite Large: The restructuring announcements suggest a substantial opportunity to improve operations, which is not that surprising given a lackluster prior management team. If you caught all of benefits from the restructuring items, it sounds as though Foodservice should spin with a substantial earnings growth opportunity baked in. Expect new management to market these, and we wouldn’t be surprised if more opportunities pop-up in Cranes as new leadership comes in.
- Foodservice: The nearer-term consolidation of the Cleveland facility is expected to result in $30 million in cost savings next year, and $40 million by 2017. Over the next 3 years, they indicated an extra 150 basis points to the margin in addition to that Cleveland restructuring.
- Cranes: There should also be a benefit from the right-sizing and capacity reductions in the Crane segment of $35 - $45 million over the next three years, with a portion of that expected next year. We should get more detail here as new leadership takes over.
Sentiment Very Negative, Inconsistent: For a company with a solid value-unlock catalyst in just four months, the analyst community certainly hates MTW. The questions from sell side analysts with higher ratings were even nasty in tone. It isn’t clear to us how the price target from the Street could have been literally cut in half over the last year. After all, it is the exact same group of businesses and the sales and margins in the Foodservice segment (the vast majority of the firm’s value) are higher today.
Cranes Not Below Prior Trough If Appropriately Adjusted: If the delay in VPC shipments is backed out, which is appropriate since it is associated with a hitch in a new product introduction, crane margins look much better – certainly above the prior cycle low. Sales in the quarter would have been about $55 - $60 million higher at a “ballpark” 25% incremental margin. Should this have been emphasized in the earnings release? Obviously. As for crane orders, the quarter was pretty weak. That is a negative, but it is hard to say if the VPC issue also delayed orders or how much is related to weaker commodity prices – an impact that should roll off as construction is the key crane end market.
Crane Orders Are Incredibly Noisy Quarter To Quarter: The September quarter is typically the seasonally weakest.
TTM Less Remarkable: The trailing 12 month orders for the MTW crane segment shows a trend unlike the prior downcycle.
Upshot: The split is on track for February, but now with better leadership and significant identified restructuring opportunities. We think that MTW is one of the most undervalued and least understood names in the sector.
Takeaway: The Fed has raised rates 9 times since April 2014 based on Wu-Xia math. This explains a) why growth is slowing and b) why it's late cycle.
Editor's Note: Below is a complimentary excerpt from a research note written today by our Financials team. If you'd like more information on how you can subscribe to our institutional research please send an email to firstname.lastname@example.org.
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Claims are maintaining steady strength below 330k, rising by just 1k last week to 260k. However, even with claims now marking their 20th month below the 330k level, the Federal Reserve once again held the Fed Funds rate flat at zero yesterday. Last week, as we show in the chart below, we pointed out that this delay in a rate increase appears to be different versus previous cycles. Historically, by now the Fed would already be well underway raising rates. This is one of the arguments put forward by bulls for why the current cycle may not yet be long in the tooth.
The reality, however, is that the Fed has actually been tightening policy since December 2013 when it began tapering QE3. Interestingly, as Christian Drake of our Macro Team pointed out, the Fed actually quantifies the effect of the current cycle's non-traditional policy action and the tapering thereof in the chart below with a measure called the Wu-Xia Shadow Fed Funds Rate (HERE). The Shadow Rate is basically the rate the Fed has set by implementing non-traditional policies. The following chart shows that we have been in a rising rate environment since April, 2014 and the effective Fed Funds rate has risen ~225 bps to -0.75% from -3%. This is one of the main reasons why a) growth is now slowing and b) the cycyle is, in fact, very late stage.
On the energy front, claims in energy states continue to worsen versus the country as a whole as we approach the end of the year around which point many energy firms' hedges will roll over. The chart below shows that in the week ending October 17, the spread between the indexed series of energy state claims and country-wide claims widened to 22 from 20 in the prior week.
Initial jobless claims rose 1k to 260k from 259k WoW. The prior week's number was not revised. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -4k WoW to 259.25k.
The 4-week rolling average of NSA claims, another way of evaluating the data, was -9.2% lower YoY, which is a sequential improvement versus the previous week's YoY change of -8.2%
Takeaway: Investors contributed to both risk asset classes last week but contributed more to bonds than equities, favoring measured risk.
Investment Company Institute Mutual Fund Data and ETF Money Flow:
Risk assets rebounded across the board in the 5-day period ending October 21st, signaling a temporary reduced level of worry in the marketplace. However, the +$6.0 billion net flow into total bond products (both mutual funds and ETFs) outpaced the +$3.3 billion inflow into total equity products, as investors still favored the relative safety of bonds over stocks. Only domestic equity mutual funds and hybrid mutual funds experienced redemptions last week with all other categories seeing new subscriptions as investors looked again to put money to work.
Additionally, money funds continued to rebuild balances, gaining another +$1 billion in contributions last week, bringing the 4Q15 total inflow to +$30 billion. This trend supports our Long recommendation on leading money fund manager Federated Investors (see our FII report). The long running equity bull market has been sourced by money coming off the sidelines and out of money funds which is why a late stage setup in equities should unwind the constant 6 year draw down in cash products. While cash balances in 3Q15 and 4Q15TD have started their seasonal rebuild with +$54 billion and +$30 billion moving back into the category, we note the substantial run in the S&P 500 has resulted in 20 out of 36 quarterly outflows in industry related cash products, with over $1.1 trillion being redeemed. As equities enter 2016 and beyond and into the late stages of this current economic expansion, this is the opportunity for leading money fund managers including Federated, BlackRock, and Legg Mason.
In the most recent 5-day period ending October 21st, total equity mutual funds put up net inflows of +$1.5 billion, outpacing the year-to-date weekly average outflow of -$357 million and the 2014 average inflow of +$620 million. The inflow was composed of international stock fund contributions of +$1.6 billion and domestic stock fund withdrawals of -$70 million. International equity funds have had positive flows in 46 of the last 52 weeks while domestic equity funds have had only 10 weeks of positive flows over the same time period.
Fixed income mutual funds put up net inflows of +$3.1 billion, outpacing the year-to-date weekly average inflow of +$113 million and the 2014 average inflow of +$926 million. The inflow was composed of tax-free or municipal bond funds contributions of +$405 million and taxable bond funds contributions of +$2.7 billion.
Equity ETFs had net subscriptions of +$3.3 billion, outpacing the year-to-date weekly average inflow of +$1.9 billion and the 2014 average inflow of +$3.2 billion. Fixed income ETFs had net inflows of +$2.8 billion, outpacing the year-to-date weekly average inflow of +$1.2 billion and the 2014 average inflow of +$1.0 billion.
Mutual fund flow data is collected weekly from the Investment Company Institute (ICI) and represents a survey of 95% of the investment management industry's mutual fund assets. Mutual fund data largely reflects the actions of retail investors. Exchange traded fund (ETF) information is extracted from Bloomberg and is matched to the same weekly reporting schedule as the ICI mutual fund data. According to industry leader Blackrock (BLK), U.S. ETF participation is 60% institutional investors and 40% retail investors.
Most Recent 12 Week Flow in Millions by Mutual Fund Product: Chart data is the most recent 12 weeks from the ICI mutual fund survey and includes the weekly average for 2014 and the weekly year-to-date average for 2015:
Cumulative Annual Flow in Millions by Mutual Fund Product: Chart data is the cumulative fund flow from the ICI mutual fund survey for each year starting with 2008.
Most Recent 12 Week Flow within Equity and Fixed Income Exchange Traded Funds: Chart data is the most recent 12 weeks from Bloomberg's ETF database (matched to the Wednesday to Wednesday reporting format of the ICI), the weekly average for 2014, and the weekly year-to-date average for 2015. In the third table are the results of the weekly flows into and out of the major market and sector SPDRs:
Sector and Asset Class Weekly ETF and Year-to-Date Results: In sector SPDR callouts, investors redeemed -$420 million or -5% from the industrials XLI ETF while contributing +$436 million or +4% to the energy XLE.
Cumulative Annual Flow in Millions within Equity and Fixed Income Exchange Traded Funds: Chart data is the cumulative fund flow from Bloomberg's ETF database for each year starting with 2013.
The net of total equity mutual fund and ETF flows against total bond mutual fund and ETF flows totaled a negative -$1.2 billion spread for the week (+$4.8 billion of total equity inflow net of the +$6.0 billion inflow to fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52-week moving average is +$1.6 billion (more positive money flow to equities) with a 52-week high of +$27.9 billion (more positive money flow to equities) and a 52-week low of -$19.0 billion (negative numbers imply more positive money flow to bonds for the week.)
Exposures: The weekly data herein is important for the public asset managers with trends in mutual funds and ETFs impacting the companies with the following estimated revenue impact:
Jonathan Casteleyn, CFA, CMT
Joshua Steiner, CFA
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