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The Stock Market Is Out of Breadth and Overstretched

Takeaway: We see a lot of risks in the market's recent run-up.

The Stock Market Is Out of Breadth and Overstretched - Hindenburg

 

Our Macro team continues to question whether the recent equity market run-up is getting long in the tooth.

 

It was the same question Hedgeye Macro analyst Darius Dale posed back in July. (You remember how that ended in August.) Click the image below to read Dale’s previous note.

 

The Stock Market Is Out of Breadth and Overstretched - darius dangerous highs

 

To update his previous research, Dale looked at the Russell 3000 (which is 98% of the investable public equity market) and, specifically, the percentage of stocks currently trading below their 200 day moving average to gauge the breadth of the market’s recent advance. 

 

See the chart below which shows that 53.6% of stocks are below their 200-day moving average. To put that in perspective, back in May that reading was 39.1%.

 

The Stock Market Is Out of Breadth and Overstretched - darius breadth 2

 

As Dale notes:

 

“… While not useful as a [market] timing indicator, the aforementioned deterioration does imply the duration and scope for prospective returns are substantially worse than many investors may assume given consensus expectations for the length and strength of the current economic cycle…”

 

The Stock Market Is Out of Breadth and Overstretched - darius twitter expansions


DRI | ARE OLIVE GARDEN EXPECTATIONS TOO HIGH?

Darden Restaurants (DRI) remains on the Hedgeye Restaurants SHORT bench.

 

We like it when you can keep a thesis on a stock simple and straightforward!  Expectations for a recovery at Olive Garden have gotten way ahead of reality.

 

DRI is going to report EPS in early December and the chances are high they have a good quarter.  The current street estimate for Q2 ’15 is $0.42, up 50% YoY.  Since November ’14 that estimate has moved up from $0.34, so expectations have increased 24% over the past 12 months.  In addition, since Jan ’15 the estimate for FY ’16 has gone from $2.99 to $3.68, up 23%.    

 

Over the last three quarters the company has beaten estimates by 18%, 16% and 18%, respectively.  I suspect the company can beat the number but the days of the “big beat” and raise are over.   

  

It’s been a year since Chairman Jeff Smith and his team took over Darden and what a year it’s been.  Consider the following improvements to the P&L:

  • Consolidated SSS have gone from flat to nearly 3% growth
  • SSS for the OG have gone from 0.5% to 2.7% in 1Q16
  • LTM Food Costs have improved 56 bps
  • LTM Labor Costs have improved 34bps
  • LTM Other Expenses have improve 95bps
  • LTM Restaurant Margins up 186bps
  • LTM G&A has improved 81bps
  • LTM Operating Margins have improved 310bps
  • EPS has nearly doubled to $3.17 over the last four quarters

 

Management has executed a strong recovery in financial performance over the past 12 months.  As you can see most of the gains have come from below the line cost cutting items, which are one time in nature.  Importantly, the company has announced and filed the relevant docs to create a new real estate company.  I understand there is an arbitrage that creates value by putting the OG rents in a vehicle, but what’s left is also very important.

 

As of 1Q16 this is what management is doing to post sustainable same-store sales growth at OG:

  • Value Proposition -  “Olive Garden is where people of all ages gather to enjoy the abundance of great Italian food and wine, and to be treated like family”
  • Leveraging Core Brand Equities – Breadstick nation and Tour of Italy
  • Table top tablets
  • Refresh 19 restaurant with 25 more planned for 2016

 

As you can see there is not an abundance of new innovation and management is not investing behind the brand or the assets!  As you can see from the chart below street expectation call for a significant acceleration is 2-year sales trends at Olive Garden.  As we see it the slope of the red line is way too steep given there is little investment in the OG brand and the industry trends are slowing.     

DRI | ARE OLIVE GARDEN EXPECTATIONS TOO HIGH?  - CHART 1

 

Given the current overall industry is slowing down, is it possible the trends at Olive Garden are that good? We don’t think it is logical to think that in 6 months Olive garden will be doing a 2.2% same-store sales on a 2-year basis.

 

Olive garden is the engine of growth for DRI.  Olive Garden represents 56% of sales for the company we believe accounts for roughly 42% of the total value of the company after parsing out the REIT.  Where Olive Garden goes, Darden goes.

 

Multi-concept casual dining restaurant companies struggle for the simple fact that it is difficult to allocate capital correctly. OG needs a lot of capital to reassert itself in the market while you have growth engines like Capital Grille and Yard House that need it in order to grow. The simple fact is Olive Garden is not getting the attention/capital it needs in order to return to meaningful long-term growth. This thinking coupled with a slowing casual dining industry is not good news for Olive Garden and the other concepts at Darden.

 

VALUATION

In a slowing sales environment with compressing casual dining multiples, if DRI were to trade at one of its closest competitors multiple, EAT, there is downside to the low $40’s.

DRI | ARE OLIVE GARDEN EXPECTATIONS TOO HIGH?  - CHART 2

 

Please call or e-mail with any questions.

 

Howard Penney

Managing Director

 

Shayne Laidlaw

Analyst

 

 


ICI Fund Flow Survey | The Trillion Dollar Bet

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.

 

ICI Fund Flow Survey | The Trillion Dollar Bet - z chart1

 

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.

 

ICI Fund Flow Survey | The Trillion Dollar Bet - z black red

 

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:

 

ICI Fund Flow Survey | The Trillion Dollar Bet - ICI2

 

ICI Fund Flow Survey | The Trillion Dollar Bet - ICI3

 

ICI Fund Flow Survey | The Trillion Dollar Bet - ICI4

 

ICI Fund Flow Survey | The Trillion Dollar Bet - ICI5

 

ICI Fund Flow Survey | The Trillion Dollar Bet - ICI6



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.

 

ICI Fund Flow Survey | The Trillion Dollar Bet - ICI12

 

ICI Fund Flow Survey | The Trillion Dollar Bet - ICI13

 

ICI Fund Flow Survey | The Trillion Dollar Bet - ICI14

 

ICI Fund Flow Survey | The Trillion Dollar Bet - ICI15

 


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:

 

ICI Fund Flow Survey | The Trillion Dollar Bet - ICI7

 

ICI Fund Flow Survey | The Trillion Dollar Bet - ICI8



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.

 

ICI Fund Flow Survey | The Trillion Dollar Bet - ICI9



Net Results:

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.)

  

ICI Fund Flow Survey | The Trillion Dollar Bet - ICI10

 


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:

 

ICI Fund Flow Survey | The Trillion Dollar Bet - ICI11 


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MACAU: OCTOBER NOT SO GOLDEN

CALL TO ACTION

We’ve had a long Macau call on since late September but we fear the end of that trade is near. October was certainly better than September (seasonally adjusted) but it did trail off after Golden Week. High hold benefited the market, otherwise the YoY decline would’ve had a 3 in front of it rather than the actual 28% drop. The incremental data points for Macau Studio City will likely be negative, casting doubt on ROIs of the new Cotai properties and whether new supply will drive incremental visitation/GGR growth. Looking at November, we think the month is off to a sluggish start and our GGR forecast for the month of a 31% decline is larger than October’s and worse than Street expectations of a mid-20s drop. Finally, our 2016 EBITDA estimates remain well below the Street. Keep a trade a trade has been our mantra on Macau for the past several weeks and it looks like a good time to book profits.

 

We will be hosting a Macau call on Friday Nov 6th at 11AM to present more analysis on the October numbers, our model projections and outlook, and a new research topic. Please contact your Hedgeye salesperson for more details.

 

 Please see our detailed note: 

http://docs.hedgeye.com/HE_Macau_11.4.15.pdf

 


HOWARD PENNEY ON THE MACRO SHOW THIS MORNING TALKING FOOD

This morning we were on Hedgeye's The Macro Show talking about Restaurant stocks. We gave an overview of the earnings season to date and touched on a few things to look at in Q4 and 2016.

 

Watch the replay below:


Timber... Still A Long Way To Fall for Kinder Morgan | $KMI

Takeaway: If you still own shares of Kinder Morgan, we suggest you tread very carefully.

In case you missed it... Barron’s ran a story with the headline below over the weekend. The story prominently features the analysis of Hedgeye Energy analyst Kevin Kaiser. Of course, Kaiser has been a longtime bear on Kinder Morgan (KMI) and a vocal critic of the dangers of MLPs.

 

Barron’s writer Andrew Bary calls Kaiser, “the company’s most outspoken critic.” We won't disagree with his assessment. 

 

Timber... Still A Long Way To Fall for Kinder Morgan | $KMI - z barrons headline

 

Here’s an excerpt::

 

“… Hedgeye’s Kaiser takes issue with investors’ dividend focus: ‘You need to look at other metrics because the dividend is an arbitrary number that is not representative of what the company actually earns.’

 

The company is expected to net 70 cents a share this year, based on generally accepted accounting principles. With a tax shield related to the MLP purchases last year, the cash earnings may top $1 a share. So Kinder Morgan’s current dividend could be about twice its cash earnings and more than three times its free cash flow, as defined by cash flow from operations, less all capital expenditures.”

 

Timber... Still A Long Way To Fall for Kinder Morgan | $KMI - 11 3 2015 kmi bary

 

Kaiser’s original short call on Kinder Morgan came on 8/2/2013 when shares traded for almost $39. Yesterday, KMI closed at $27.51 per share. In other words, the stock is down 30% since Kaiser’s call. 

 

Contrast Kaiser’s steadfast thinking with Wall Street's perma-bulls, who are increasingly hedging their bets. In the Barron’s story, writer Andrew Bary singles out Credit Suisse MLP analyst John Edwards as a “longtime Kinder bull.”

 

While we wouldn’t say Mr. Edwards has swung around to our dour outlook on the stock just yet, at a minimum, he's at least pulling his expectations down from the stratosphere. Following KMI’s disappointing Q3 earnings, Edwards cut his rating on the stock to "Neutral" from "Outperform." He also lowered his price target to $39 from $52.

 

It's a start!

 

The stock was up 3.4% yesterday, rebounding from its 15% tumble after the company reported lackluster earnings.  

 

Timber... Still A Long Way To Fall for Kinder Morgan | $KMI - Kinder Morgan

 

We're obviously not buying the bounce

 

In a recent note to subscribers, Kaiser reiterated his short call and explained why he continues to peg fair value for KMI in the range of 9x to 10x current EV/EBITDA, or $10-$13 per share.

 

In other words, at least 50% downside from here.

 

Bottom line: Kaiser has been warning about the dangers of MLPs for a long time now. Check out this laundry list of 8 MLP short calls he's made and how they have fared here. If Kaiser is right again, it doesn’t bode well for Kinder Morgan shareholders.

 

Timber... Still A Long Way To Fall for Kinder Morgan | $KMI - 11 4 2015 kmi prop

 

***If you’d like to learn more about how you can subscribe to Kevin Kaiser’s research as well as our other institutional research, please email sales@hedgeye.com.


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