Cartoon of the Day: Happy Hour?

Cartoon of the Day: Happy Hour? - Oil cartoon 11.20.2015


"Oil is looking to snap $40 WTI again as the Dollar ramps on Mario “Whatever It Takes” Draghi trying to bend/smooth economic gravity," wrote Hedgeye CEO Keith McCullough today in a note to subscribers. "You can expect that most October “reflation” data is going to mean revert to bearish trend here in November as commodities crash."

CAT | Spin the Bulldozer

Upshot: CAT shares are already under pressure, and we likely wouldn’t press a short position on this week’s events.  However, the Cat Financial analyst day continues to suggest that our take on this large and opaque division is on the right track.



Some Relevant Prior Publications


Feeling Used? CAT Black Book (latest of many)



Persistent and Substantial Concern


We have been ‘short’ CAT since launching Hedgeye Industrials in 2012, and our next downside catalyst has been investor concern over the firm’s captive finance subsidiary (e.g. see Retrieving Your Excavator From Botswana).  We are getting that now.  Caterpillar Financial is large, leveraged, and opaque - not a great combination in troubled times.  For us, it is a largely straightforward march from excess resource-related equipment to lower collateral values and distressed borrowers.  Investor concern about Cat Financial has been building, and has already likely been a driver of share price weakness.  Those concerns should persist, dissuading value-trap seeking buyers.




  • Sloppy Faux Disclosure: Slide 13 of the presentation mattered, but the colors and units did not match the charts. More importantly, there were NO DEFINITIONS provided for the calculations or industries.  This slide wouldn’t make it through a middle school math class, and we would guess that the ‘definition wiggle room’ is intentional.  The new disclosures do not reconcile with previous filings, with Mining exposure 2x the prior disclosure.  We think it will eventually be re-re-disclosed at even more than 2x.
  • Agenda & Pulling Teeth: The presentation was apparently targeted at alleviating concern, but the ambiguity of the new disclosures may backfire. It screams to us “hey, look at how totally incomprehensible and irreconcilable my Finance segment disclosures are.” Good luck with the follow-ups, too, as CAT’s usually top-shelf IR department said they “don’t disclose that level of detail” when asked about mining-related exposures in categories other than “Mining”.  If it weren’t there, they probably would have said as much.  If it sounds like a silly question, recall Mining didn’t previously capture all of Mining, which is how we got a doubling of the disclosed exposure.
  • Street Appeared Utterly Clueless On Cat Financial:  CAT only allows Q&A from bulge bracket sell-siders, who have apparently only recently realized that prior portfolio disclosures were not useful.  They failed to press for detail on the new disclosures, like how much of Cat Dealer/Wholesale is backed by mining equipment.  Shortly, the street is likely to realize that Cat Financial cannot really be diversified since the captive finance sub only lends to CAT customers backed by CAT products. That is not a diverse group by our portfolio management standards.


CAT | Spin the Bulldozer - CAT 11 20 15



Bullish On First Glance:  At first, the Caterpillar Financial analyst meeting presentation looked pretty good for CAT.  The portfolio exposures had not been previously disclosed by industry or really in any useful format as we see it.  Slide 13 showed Cat Financial to have a reasonably diversified portfolio, with the larger exposures from North America, small borrowers, and Dealers.  None of that seems so bad, right?  But Caterpillar Financial’s collateral is all Caterpillar equipment, and how diversified can that really be?  A closer look raises some interesting questions. 



Mining Exposure: Half Is Not A Large Majority


“Most of it, the large majority of it shows up in the mining segment as broken out in our public filings with the SEC.” – James A. Duensing


First, A 2X Surprise:  “Mining” was only 13% of the new pie chart.  Of course, that 13% probably came as a surprise to many people, since “Mining” as disclosed in the 9/30/15 10-Q was only 6.7% of the portfolio.  Now it is roughly twice that.  We had known and written that 10-Q disclosure was not accurate previously.


CAT | Spin the Bulldozer - CAT 2 11 20 15

Source: Caterpillar Financial 9/30/15 10-Q



CAT | Spin the Bulldozer - CAT 3 11 20 15

Source: Caterpillar Financial Analyst Day Presentation, HRM



New Number Accurate?  If you can move past the unmatched colors, which certainly imply something, it is worth asking – is 13% actually the right number for Mining exposure?  CAT won’t really answer that question, but we are pretty sure that the answer is NO.  


Where Will Mining Go Next?  We would bet that “Special Trade Contractors”, “Services”, and/or “Cat Dealer/Wholesale” also contain mining exposure.  First, not all mining equipment is operated by mines, and mining contractors have been more likely to sell used equipment of late (Used Mining Equipment Values Call with Michael Currie  We would expect “Cat Dealer/Wholesale” portion, which we presume has the Caterpillar Purchased Receivables, to contain actual trade exposure to mining.  Readers can check the Joy Global 3Q15 earnings call transcript to see how that is working out.  And what, exactly, is “Services”?  We would expect the disclosed Mining exposure to move higher on these slippery definitions. 


Mislabeled Customer Exposure Table:  The Customer Exposure pie chart is labeled as (Millions of USD), so any reasonable reader might assume that pie chart shows the dollar value of the portfolio from each loan size category.  But it is not – it is mislabeled in a way that makes Caterpillar Financial look more diversified.  When asked, CAT disclosed that the chart “shows a percentage of our customers with exposure in the various exposure categories”.  If that >$3.0 million slice were 10%, which would still look small and manageable, it would equal >$43 billion in portfolio exposure (bigger than the actual portfolio).  This chart may look reassuring, but provides little specificity on Cat Financial’s customer concentration.  Are we expected to believe that a Fortune 500 company doesn’t know how to properly put units on a pie chart?  Or did management prefer the message conveyed by the inaccurate units?


CAT | Spin the Bulldozer - CAT 4 11 20 15

Source: Caterpillar Financial Analyst Day Presentation, HRM



Residual Values


“Almost 90% of the machines that we have from off of a lease conversion or from repossession will be remarketed and sold through the Caterpillar channel.” - Kent M. Adams


Dealer Resale:  A function of a captive finance subsidiary is often to keep residual values high by making sure the sale of used equipment happens in an orderly fashion.  It seems to us that CAT is holding equipment off the market, in large part because we have been tracking increased used equipment for sale (to see our recent black book, CLICK HERE).  Investors should consider how that can end…


“And then we look at usually a three-year to five-year moving average in terms of historical prices of machines based on our database and how we set that residual, and we set those residuals annually.” - Kent M. Adams


Reset Should Be Interesting:  Used equipment values are down pretty much across CAT’s major product categories.  While it may take time to flow through to the assumptions, it likely will in our expectations.  That is, unless, the “qualitative” part of the reserve process intervenes, as we suspect it did last quarter.  Just wait for actual mine closures to see real aftermarket price pressure.  Construction equipment is already troubled.  


CAT | Spin the Bulldozer - CAT 5 11 20 15



We Will Stop Here:  We could go on and on about the analyst call, but we suspect that our point is clear.  This is a topic that is still building and may take quite a while to work through. 


Upshot: CAT shares have already been under pressure, and likely wouldn’t press a short position on this week’s events.  However, the Cat Financial analyst day continues to suggest that we are on the right track in expecting eventual problems from this large and opaque division.





We are removing WEN from the SHORT list and moving it to the LONG bench.


With MCD digging itself out of a deep hole, there are lots of moving parts in the restaurant industry these days.  While we have been critical of WEN not doing better when they had a chance to take share over the last three years, the lack of volatility in their sales trends are working out in their favor.


It appears that WEN has found the right balance of improving the asset base; franchisee optimization and now a marketing plan that is resonating with consumers.  As you can see from the table below WEN same-store sales trends have been improving on a 1, 3 and 5-year basis. 



Despite our initial concerns about the impact that MCD might have, we believe WEN internals changes will lead to an acceleration of same-store sales trends over the next 12-months.  In the short run the company’s 4 for $4 will drive incremental sales above the consensus estimates for 4Q15.





More details to come. Please call or e-mail with any questions.


Howard Penney

Managing Director


Shayne Laidlaw






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Investing Ideas 'Macro Overlay': Style Factors You Want in Your Portfolio Now

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3 Reasons Why Under Armour Won’t Acquire Lululemon | $UA $LULU

Takeaway: UA buying LULU would be one of the most painful mergers in retail history. The big winner would be Nike. That's why it won't happen.

3 Reasons Why Under Armour Won’t Acquire Lululemon | $UA $LULU - lulu


Just because UA’s 43x EBITDA multiple suggests it CAN buy Lululemon at 15x, does not mean it SHOULD. If it does, we think it will make UA a tremendous short. But we won’t ever make that call, because the likelihood of UA buying LULU is about as high as Nike buying Uber.


Key Considerations


  1. UA wants to beat LULU organically. Not just beat it, but kick it once it’s down, and dance over its grave.
  2. UA would have to pay $7-8bn for the ‘privilege’ of owning one of the worst-managed brands in retail. That might be ok if UA had experience fixing things. But it doesn’t. Plus, why acquire a company it can beat organically with less than 1/10th the capital allocation.
  3. The last, and most important factor is Culture. You simply cannot find two more polar opposite cultures (let us know if you can think of any). LULU is a company based on a tree-hugger yogi mentality with little concern for planning, analysis, and close to no sense of urgency. UnderArmour is filled with amazingly energetic, Type-A high-performance athletes camouflaged in business casual clothes. Imagine JJ Watt (DE Houston Texans) in full gear doing ‘warrior pose’ in a peaceful yoga studio…with Nancy Pelosi. That’s about how awkward the cultural matchup here would be.


This would be the modern-day equivalent of when Adidas bought Reebok back in 2006. That handed Nike 10 points of share in Footwear. Rest assured that Nike execs are praying that UA buys LULU. That’s why it won’t happen.



Editor’s Note: This is a brief, abridged excerpt from a more detailed research note sent to subscribers by Retail analyst Brian McGough. To read the entire note and learn more about subscribing to our Retail sector research, ping

FMHQ (Friday Morning Housing Quant)

Takeaway: Housing stocks bounced notably in the latest week, but continue to modestly lag the market more broadly.

Our FMHQ (Friday Morning Housing Quant) tables present the state of the publicly traded homebuilders in a visually-friendly, quantitative format that takes about 60 seconds to consume. 



  • Performance Roundup: Housing resumed its normal 4Q seasonal momentum in the latest week with the average builder up 3.0% on the week vs the S&P 500 rising 1.7%. This brings the QTD performance back into solidly green territory. QTD absolute returns for ITB and XHB stand at +7.2% and +5.0% vs the S&P 500 +8.4%. Meanwhile, the average builder from our tables below is now +2.1% QTD. Our preferred four horsemen of 4Q among builders are NVR, LEN, BZH & KBH, which are +8.4%, +5.1%, +6.2%, Unch'd QTD, respectively. The three best performing builders thus far this quarter are DHI (+9.2%), NVR (+8.4%) and TOL (+8.1%), while the three worst performing builders are TMHC (-10.5%), HOV (-5.1%), and MTH (-3.1%).
  • Insider Buying: Other than the Director at Hovnanian (HOV) who purchased 20k shares (~$45k) in late October, there's been no recent insider buying in the sector.
  • Beta: The highest beta names (1YR) remain HOV (1.52), KBH and BZH which are at 1.33 and 1.36, respectively. At the other end of the spectrum, the lowest beta plays are NVR (0.61), MDC (0.93) and TOL (1.00).
  • Short Interest: CAA, KBH and DHI have seen SI creep higher, rising as a % of SO by 5.0%, 4.2% and 1.5%, respectively in the latest month. TMHC, HOV & MTH have seen SI fall by 2.3%, 2.0% and 1.8%, respectively.
  • Valuation: The cheapest names in the group currently are BZH (7.5x), MTH (9.6x) and TMHC (9.2x), while the most expensive are NVR (15.2x), LEN (13.3x), and TOL (13.6x). Incidentally, NVR, at 5.3x TBV, is currently at 99% of its peak 5-year valuation.


FMHQ (Friday Morning Housing Quant) - BQ1

FMHQ (Friday Morning Housing Quant) - BQ2


FMHQ (Friday Morning Housing Quant) - BQ3


FMHQ (Friday Morning Housing Quant) - BQ4



Joshua Steiner, CFA


Christian B. Drake

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