"The Fed's 'forecast' is wrong 70% of the time," Hedgeye CEO Keith McCullough wrote earlier today. "They are the new market risk."
Takeaway: Retail analyst Brian McGough sees #LateCycle risk in Macy's numbers.
Macy’s shares are getting crushed today. The department store giant’s stock is down 14% after reporting troubling 3Q earnings. Are Macy’s poor performance emblematic of a broader economic trend playing out, perhaps even of an emerging consumer recession?
We think so.
Whether you look at durable goods, consumer confidence, industrial production, ISM Manufacturing, company earnings (the list goes on and on), the data appears to be rolling over.
Macy’s CEO Terry Lundgren seems to think so too. In fact, his presence on today’s earnings call spoke volumes in and of itself. As Hedgeye Retail analyst Brian McGough pointed out in a note to subscribers this morning, it was the first time that Lundgren had participated in an investor call since 4Q 2009. Back then, Lundgren was taking a victory lap of sorts, after Macy’s had emerged from the recession with a clear vision forward.
How times have changed. In its most recent quarter, Macy’s sales were down 5%, inventories up 5%, and the company lowered full-year revenue and profit guidance. “The company didn’t have a whole lot to get bullish about,” wrote McGough.
Furthermore, if Lundgren’s presence this go-around was meant to downplay Macy’s poor quarterly results, he did an equally poor job of it. Here’s an excerpt from McGough’s research note:
“Arguably the most troubling factor from our vantage point is that Lundgren said "We believe that the retail industry is going through a tough period that we seem to experience something like this every five to seven years or so, and this one feels familiar in that regard."
And a tweet from Keith.
So while he didn’t come right out and drop the “R” word (Recession), we can read between the lines. In his research note, McGough offers his thoughts:
“He probably did not mean this to sound so dire, and softened it up accordingly after seeing the stock down double digits (his recoil didn’t work). But our concern is that growth is definitely slowing in the broader economy, and it appears to be very late-cycle.
But it does not feel like a recession – yet. If Macy’s is putting up numbers like this and making these statements today, what happens when (not if) the US economy contracts again? We certainly don’t want to be there when that happens.”
Macy’s is just one more example of what our Macro team has been calling out for a while now, #LateCycle and #GrowthSlowing.
Don’t say we didn’t tell you so.
Takeaway: JOLTS report tomorrow, be ready!
We went into the studio to present a couple of key charts and take Q&A. We touched on the VRX conference call, and touched on AHS and other names we are short for the #ACATaper. Be ready for the JOLTS update tomorrow from BLS, it should be interesting and will tell you more than last Friday's employment report!
The slides and video from yesterday are linked below with a few key ones below.
Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.
Takeaway: A small taste of when the economy really weakens. Numbers still too high. REIT value no longer a crutch. This name can get a lot cheaper.
Conclusion: This might have been the longest Macy’s conference call in over a decade, but from where we sit, the conclusion on the stock is quite simple. Stay away from it. Is it an outright short? Maybe not after today’s steep sell-off. But we think that numbers are too high, even after the company’s guide down. At 10x earnings, 6x EBITDA, and a 9.5% FCF yield, it certainly looks cheap – but it had the same multiples yesterday before the earnings print. At this point, it’s all about earnings, and unfortunately, expectations for next year are high by over 10%. Consider the following: a) we’re late in an economic cycle, b) the CEO just said it is the worst sales environment in 5-7 years, c) there’s no clear path to recovery (potentially ever), and d) one of the biggest bull cases (REIT) was just blown up. At this point, we think people are probably going to test the low end of the valuation spectrum until they have confidence that numbers have bottomed. For department stores like Macy’s, that’s 7-8x earnings, 4-4.5x EBITDA, and 15%-20% FCF yield. If our model is right, that implies a stock in the high-$20s. This is one we’re going to avoid, and will short on green as we gain confidence in our model.
There was a lot of information in this print. Let’s focus on the Majors.
1) Terry Lundgren Saves The Day – Kinda. Macy’s CEO was on the conference call for the first time since 4Q09 – when he took a victory lap after implementing MyMacy’s as we emerged from the Great Recession. But this guest appearance by the man was anything but a victory lap. It was intended to be a fire retardant. It didn’t work.
2) This Was All About Being Accountable to Activists. Let’s be clear on why Lundgren was on the call. It was not to discuss weak sales trends, strategic plans or financial results. Karen Hoguet (CFO) is about as savvy as they come, and could easily handle this on her own. He needed to be on the call to be accountable to all the activist investors who have been in very close contact with Macy’s over the past year about converting into a REIT – something we’ve long viewed as financially and logistically impractical. Management stated as plain as day that Macy’s WILL NOT pursue the REIT strategy. This means if someone is invested in Macy’s for a REIT – and there are plenty who are – they probably need to either exit the position, or morph the thesis to be focused on the base business. But with sales down 5% and inventories up 5%, the company didn’t give a whole lot to get bullish about. Yes, Macy's contracted Tishman Speyer (the partner it used on the Brooklyn store) deal to find strategic/joint venture alternatives for 4 of its Flagship properties with the potential to touch more of the footprint as M rationalizes it's sq. ft. in those doors and attempts to creatively monetize a portion of its 'A' assets. But this is a far cry from monetizing 150mm square feet.
3) The 5-7 Year Itch. Arguably the most troubling factor from our vantage point is Lundgren said "We believe that the retail industry is going through a tough period that we seem to experience something like this every five to seven years or so, and this one feels familiar in that regard." He probably did not mean this to sound so dire, and softened it up accordingly after seeing the stock down double digits (his recoil didn’t work). But our concern is that growth is definitely slowing in the broader economy, and it appears to be very late-cycle. But it does not feel like a recession – yet. If Macy’s is putting up numbers like this and making these statements today, what happens when (not if) the US economy contracts again? We certainly don’t want to be there when that happens.
4) Not a Likely LBO. One investor addressed LBO math in the Q&A. We happen to disagree, in that our model only comes up with a 6.2% ROI. There are actually a few things about the model that we like. a) at a 50% premium to current levels, M could be taken out with only $5.4bn in equity, assuming 50% is funded by Senior Debt and 30% by mortgaging its stores. That also gets us leverage of 3.8x, which actually quite good for such a large deal. The problem is that in order to get a 20%+ return – a level that’s a lot more palatable to us – we need to assume a reacceleration in sales and margins to new peak. In other words, we need to go another 5-years without an economic downturn.
Takeaway: The shift from active to passive in equities continues to rage and cash balances continue to perk up in 2H15.
Editor's Note: This is a complimentary research note which was originally published November 5, 2015 by our Financials team. If you would like more info on how you can access our institutional research please email firstname.lastname@example.org.
Investment Company Institute Mutual Fund Data and ETF Money Flow:
In the 5-day period ending October 28th, investors flocked to equity ETFs inserting +$9.5 billion in passive stock products, the third largest weekly contribution this year. Conversely, active equity mutual funds continue to be the source of funds, with another -$2.8 billion being redeemed from all U.S. stock fund managers. This shift from active to passive has been rolling for almost a decade now however with still over $7 trillion in active equity mutual funds versus $1.6 trillion in U.S. equity listed ETFs, there is still plenty of market share to be gained. The chart below outlines that the -$595 billion in redemptions in U.S. mutual funds since 2007 has resulted in +$855 billion in new inflow into all passive products (index mutual funds and ETFs). This trend has continued throughout 2015 with a -$125 billion redemption in active U.S. mutual funds versus the +$88 billion subscription to U.S. ETFs. We recommend a short position in shares of T. Rowe Price as a way to express this ongoing shift (see our TROW reports).
Cash continues to build on the sidelines as well as of the most recent survey with another +18 billion recorded by ICI in cash products as of October 28th. Money funds have now brought in +$48 billion in the fourth quarter to date, following a $67 billion build in the third quarter. In addition, the news of Bank of America transferring its +$80 billion money fund portfolio to BlackRock could be a trend to come as banking organizations start to move pools of assets that trigger capital charges under forming rule sets. We continue to like the cash management space and out of favor Federated Investors (see our FII report) on a combination of positive balance builds and profitability inprovements in the business for '16/'17.
In the most recent 5-day period ending October 28th, total equity mutual funds put up net outflows of -$2.7 billion, trailing the year-to-date weekly average outflow of -$412 million and the 2014 average inflow of +$620 million. The outflow was composed of international stock fund contributions of +$62 million and domestic stock fund withdrawals of -$2.8 billion. International equity funds have had positive flows in 46 of the last 52 weeks while domestic equity funds have had only 9 weeks of positive flows over the same time period.
Fixed income mutual funds put up net inflows of +$3.9 billion, outpacing the year-to-date weekly average inflow of +$201 million and the 2014 average inflow of +$926 million. The inflow was composed of tax-free or municipal bond funds contributions of +$1.2 billion and taxable bond funds contributions of +$2.7 billion.
Equity ETFs had net subscriptions of +$9.5 billion, outpacing the year-to-date weekly average inflow of +$2.1 billion and the 2014 average inflow of +$3.2 billion. Fixed income ETFs had net inflows of +$917 million, trailing 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, the healthcare XLV ETF took in +6% or +$757 million in contributions. The energy XLE on the other hand lost -4% or -$477 million.
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 positive +$2.0 billion spread for the week (+$6.8 billion of total equity inflow net of the +$4.8 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 +$1.4 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:
Wondering about a December Fed rate hike? The latest news comes from San Francisco Fed president John Williams who told USA Today in an interview Tuesday that there is a “very strong case” for a rate hike this year “assuming the data are consistent with those [conditions].” That's an important caveat.
Once again, it’s the pesky data that could screw everything up for rate-hike prognosticators. And the parlor game goes on...
In good faith and as part of our daily process here at Hedgeye, yesterday, CEO Keith McCullough went hunting for so-called economic “green shoots,” those bright spots in the daily data that might support a perma-bull equity thesis. In short, he couldn’t find much. But he did see a number of red flags.
To be clear, we remain very concerned that the Fed will, in fact, be hiking interest rates into an economic slowdown.
Earlier today, McCullough isolated one key data point flashing green, but it’s actually another notch in favor of the bears.
Here’s a chart of the strengthening dollar:
... And McCullough’s analysis in a note to subscribers earlier this morning:
“Relentless USD strength as my Berkeley boy Williams (San Fran Fed) hits USA Today with the ‘recent data supports a rate hike’ – I guess he missed all the industrial/cyclical, ISM, and GDP data, but raising rates into #LateCycle slow-down is mucho deflationary for many asset prices – DEC 4th US Jobs Report up next.”
On the USA Today Williams interview news, commodities, like Copper, continued #Crashing.
Check out Oil prices too…
If you're concerned about #Deflation, like we are, it's all a bit disconcerting.
But never mind all that, says Fed president Williams. More *deep* analysis from Williams:
"I don't see much evidence of fragility or lack of momentum…At some point, just the improvement in the economy with the passage of time starts to outweigh some of the concerns of potential risk."
Stop right there. On Williams' point about “the passage of time,” remember that the current U.S. economic expansion has stretched 78 months. Our analysis of a century of economic cycles shows that the mean duration is 59 months. So with all due respect Mr. Williams, the current expansion is getting long in the tooth.
But go ahead raise rates into the slowdown. We'll see what happens...