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UAL | Adding UAL Equity Short To Best Ideas List



We have not previously added short UAL Equity to our firm’s Best Ideas list, despite numerous issues with UAL’s “adjusted” financial reporting and the broader airline renaissance thesis.  We have had the CDS on the list, which were very tight in mid-2014 and we believed offered an attractive asymmetric return potential.  However, with employment at or very near a peak for this cycle, we expect demand growth to slow and potentially turn negative in 2016.  At the same time, lower fuel prices have allowed the industry to rapidly grow capacity.  Weaker demand and rapid capacity growth are likely to prove a toxic combination...particularly for UAL. 


This isn’t a call on UAL’s report tomorrow, which should be roughly in line with the Investor Update.  UAL’s outlook may well be just as rosy as DAL’s, even though we have observed some modest pressure on UAL’s fares in recent readings.  The equity market could also bounce, taking shares of UAL higher.  However, this is a longer-term view, informed by capacity growth amid changing fleet dynamics, an expected softening of demand, and our firm’s Macro process.  Ping us for our prior Black Books and EQM/data sets for additional background.





Fade Ideal Environment:  Following a 70%+ drop in the price of oil and a halving of the unemployment rate, it would be hard for the airline environment to be better.  Our firm’s Macro team makes a strong argument for a recession, or at least a recessionary environment, in 2016.  The data are compelling.  For example, credit losses are coming from resource-related industries from coal mining to oil & gas to metals.  Credit losses typically bring broadly tighter credit.  For airlines, as we show below, the economy need not experience a downturn on the scale of the Financial Crisis for the shares to sell off sharply.  Airlines typically perform horribly on both an absolute and relative basis in periods of economic slowing.  Even the 2H 2012 slowdown took a third off shares of UAL from a much lower level.  In a recession, even “high-quality industrials” would continue to sell-off sharply.


UAL | Adding UAL Equity Short To Best Ideas List - UAL 1 1 20

h/t Hedgeye Macro



Airlines Still Beloved:  Amazingly, 100% of analysts rate Delta Airlines a Buy.  Perhaps more amazingly, 88% rate UAL a Buy.  Yet, if the recession/significant slowdown call is correct, airline shares face a disproportionately large downside.  Higher cost airlines often fail in recessions; there is little historical precedent to expect airline shares to perform defensively through a downturn.  



UAL As Tide Goes Out:  We have detailed what we view as series of accounting gimmicks that have served to boost UAL’s adjusted numbers.  We won’t rehash all of them, but here are a few:

  • Writing-up frequent flier deferred revenue on emergence and in CAL purchase accounting allocations, only to drain it through later changes to FFP assumptions at ~100% margin (we estimate this at well over $1 billion)
  • Categorizing cash paid to employees as a one-time expense; GAAP allows it, but doesn’t require exclusion from adjusted results
  • Special charges for uniforms, aircraft painting which seem fairly operating to us

UAL | Adding UAL Equity Short To Best Ideas List - UAL 2 1 20


UAL | Adding UAL Equity Short To Best Ideas List - UAL 3 1 20



In recent years, UAL has only generated free cash flow on the firm’s own metric with employment trends peaking and jet fuel prices cratering.  We see the mismatch between cash and adjusted profits as noteworthy.


UAL | Adding UAL Equity Short To Best Ideas List - UAL 4 1 20



It is not as though capacity additions have been driving the cash drain.  Domestic capacity has generally contracted and UAL has steadily dribbled away market share.


UAL | Adding UAL Equity Short To Best Ideas List - UAL 5 1 20



Domestic Capacity No Longer Disciplined:  Domestic airline capacity growth is outpacing its typical relationship to economic growth amid lower fuel costs.  This is shown below as a residual from the regression of Industrial Production to ASM growth. 


UAL | Adding UAL Equity Short To Best Ideas List - UAL 6 1 20



Which tends to be explained by fuel prices….


UAL | Adding UAL Equity Short To Best Ideas List - UAL 7 1 20



So far, demand has kept pace as lower airfares and higher employment generated adequate traffic.  In a recessionary environment, however, we expect capacity trends to prove troublesome.  Capex is up, and capacity is coming on rapidly into a deteriorating macroeconomic environment.  We have generally explained accelerated capacity growth as resulting from flattening of the incremental capacity cost curve in a lower fuel price environment (e.g. economics of older planes work better at lower fuel prices).


UAL | Adding UAL Equity Short To Best Ideas List - UAL 8 1 20


UAL | Adding UAL Equity Short To Best Ideas List - UAL 9 1 20


UAL | Adding UAL Equity Short To Best Ideas List - UAL 10 1 20


UAL | Adding UAL Equity Short To Best Ideas List - UAL 11 1 20



AAL is still roughly playing the game, but this is partly company specific. 


UAL | Adding UAL Equity Short To Best Ideas List - UAL 12 1 20



And capital spending has ramped higher.


UAL | Adding UAL Equity Short To Best Ideas List - UAL 13 1 20



UAL Cost Challenges:  For a company which has twice promised billions in cost reductions (Project Quality & Merger Synergies), UAL’s cost efforts may have limited how quickly costs have grown, although it is hard to tell if that is the case. At a November conference appearance, UAL claimed to have cut “$800 million” in 2015 non-fuel operating expenses in November, which is odd since non-fuel expenses are generally higher vs. 2014.


UAL | Adding UAL Equity Short To Best Ideas List - UAL 14 1 20



Liquidity & Net Debt:  In the best airline operating environment in a generation, UAL did not make much progress on net debt or liquidity.  The relatively small buyback activity (net of converted debt, that is) may be viewed as an error in a recessionary environment.


UAL | Adding UAL Equity Short To Best Ideas List - UAL 15 1 20


UAL | Adding UAL Equity Short To Best Ideas List - UAL 16 1 20



Senior Management Uncertainty:  We very much hope that UAL’s CEO Oscar Munoz makes a speedy recovery.  As unfortunate as it is, senior management has been lacking at the firm since Jeff Smisek was pushed out following the Port Authority scandal.  That may prove an additional challenge.


UAL | Adding UAL Equity Short To Best Ideas List - UAL 17 1 20



2015 Fuel Profits: UAL has benefited enormously from the decline in fuel prices.  We expect airfares to compete away lower fuel on a lag.  Since airfares are readily tracked daily, investors may need to move well ahead of actual changes.


UAL | Adding UAL Equity Short To Best Ideas List - UAL 18 1 20



Upshot:  We see UAL as a high cost airline with dubious financial reporting, a combination that seems a straightforward short in a recessionary environment.  Airlines are historically among the most cyclical groups, but UAL is still very much “up” and investor sentiment remains very positive despite signs of an inflection in economic activity.  We expect the shares to trade lower before airfares fully reflect the changed environment.  While this does not represent a view on UAL’s soon-to-be reported quarter, the tide appears to be moving out amid a loss of capacity discipline.  

THANK YOU | A Thoughtful Note From A Subscriber

Takeaway: Notes like the one below are precisely why we launched our firm back in 2008.

Editor's Note: Below is a note we received this past Friday from a Hedgeye subscriber. Amidst all the tumult in financial markets, it is extremely rewarding and gratifying to receive messages like this validating why we do, what we do. At its core, our firm was designed to help investors protect, preserve, and grow their wealth through treacherous market environments just like today.

*  *  *  *  *  *  *


THANK YOU | A Thoughtful Note From A Subscriber - note from subscriber


Here's the video mentioned in the note above where Hedgeye CEO Keith McCullough explains how Hedgeye was founded. It all started with a personal conversation he had with his mother.



[REWIND] Early Look: Why Sell? (7/14/15)

Editor's Note: The U.S. stock market is getting pummeled again today. Below is a particularly prescient Early Look written by Hedgeye CEO Keith McCullough on July 14, 2015, just before the July/August selloff in stocks. We've been bearish ever since and warning that the stock market's fundamentals have been breaking down. That's been the right call all year. Click here to learn more.



* * *

[REWIND] Early Look: Why Sell? (7/14/15) - EL



“Ask ourselves why we do what we do…”

-Todd Gongwer

The big picture

That’s a pretty basic leadership and risk management question. And I sincerely hope that you ask yourself that question every day. I do. Being transparent and accountable isn’t easy; especially where it all starts – with yourself.


Why did we build a firm that dares recommend you actually SELL things? Whether it’s hyped up “social” cloud stocks with “TAM multiples” or Ponzi-like MLP schemes that could only be concocted by Old Wall bankers, I’m sure glad we did.


How about the simpler market SELL calls, like the ones you should have heeded every time the SP500 is up +2-3% for 2015 YTD? The US stock market has mean reverted to DOWN YTD multiple times. I wonder if both growth and earnings slowing have had anything to do with it? Ask yourself. And be honest. Did you buy stocks expecting earnings to be down in 2015?

Macro grind

When top-down GDP growth slows, consensus needs central-planning to reflate markets. And when bottom-up earnings slow, we definitely need to beg the company to “buy back the stock.” This happens at the end of every economic cycle, fyi.


Another way to look at growth (when both US and Global growth are slowing) is to buck up for the growth that you can find. Our buddies at Morgan Stanley call this “New Tech” and, oh boy, are the chart chasers loving that stuff.

[REWIND] Early Look: Why Sell? (7/14/15) - bubble cartoon 09.30.2014

As you can see in the Chart of the Day, the “New Tech” trades at, on average 149.5x earnings. So no worries there. As long as the products are cool, I’m sure this time will be different (until they miss a sales growth whisper).


Instead of debating why you shouldn’t sell some Netflix (NFLX) at 278x earnings this morning (why not just buy one of these names that has no earnings at all? #EasierToDebate), allow me to get back to doing what I do - risk managing growth.


Let’s do #EuropeSlowing because, unfortunately post Greek Gong Show, they still had to report their data this morning:


  1. Eurozone ZEW (economic sentiment) slows again in JUL to 42.7 from 53.7 in JUN
  2. German and Spanish inflation (CPI) stalled at +0.3% and +0.1% year-over-year, respectively
  3. Swedish and Finnish  #deflation came back online with year-over-year prints of -0.4% and -0.1%, respectively
  4. Swiss Producer Prices (PPI) maintained #deflation at -6.1% year-over-year
  5. UK CPI of 0.0% y/y (JUN) and PPI of -1.5% y/y were pretty much flat with where the data was in MAY


In bottom-up-stock-picker speak:


  1. If you are a producer and you have no pricing power, that is bad
  2. If you are a consumer and you get lower-prices, that is good


The problem is that corporate profits lose during the #Deflation inasmuch as the consumer takes that spread. Now that would be a great thing for US and Global consumption demand, if only we were at the beginning (not the end) of a cycle.


NEWSFLASH: you can’t centrally plan economic cycles, age, and/or time


But you can squeeze the poor hedgie who chases high and shorts low. And, to a degree, I think that was the main driver of yesterday’s global stock market ramp to lower-all-time-highs. Here are 3 nuts to consider within that thought:


  1. CFTC non-commercial futures/options data showed a net SHORT position of -162,467 SP500 contracts
  2. Thursday’s front-month VIX close of 19.97 was at the top-end of my 13.52-20.63 risk range
  3. High Beta Stocks (in SP500 Style Factor terms) were -5.1% (vs. Low Beta +0.5%) on a 1-month duration


Oh, and Total US Equity market Volume (including dark pool) was -16% and -17% yesterday vs. its 1-month and 1-year averages, respectively. We former hedgie guys call that a no-volume squeeze.


So what do you do today? You sell.


Yep. That’s it. That’s my “call.” You look at everything you own and ask yourself whether or not what you own is at the top-end of its immediate-term risk range or not. And if it is (like SBUX is for example), you sell some.


If I’m the bad guy for thinking that way, so be it. Where I was bred in this business, when both top-down growth and bottom-up profit cycle earnings started to go from good to bad, I was taught to sell.


That’s what I did at the end of the 2000 cycle. That’s what I did at the end of the 2007 cycle. And that’s what I am telling you to do now at the end of the 2015 cycle. That’s what I do. Ask yourself what you did/do.


[REWIND] Early Look: Why Sell? (7/14/15) - asset alloca EL

Our levels

Our immediate-term Global Macro Risk Ranges (and intermediate-term TREND views in brackets) are now:


UST 10yr Yield 2.19-2.47% (bearish)

SPX 2041-2105 (bearish)
RUT 1228-1270 (bearish)
Nikkei 19899-20501 (bullish)
VIX 13.52-20.63 (bullish)
USD 95.61-97.42 (bullish)
EUR/USD 1.09-1.12 (bearish)
YEN 122.14-124.10 (bearish)
Oil (WTI) 49.08-53.14 (bearish)

Nat Gas 2.65-2.89 (bearish)

Gold 1148-1165 (bearish)
Copper 2.43-2.62 (bearish)


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


[REWIND] Early Look: Why Sell? (7/14/15) - tech valuation

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This indispensable trading tool is based on a risk management signaling process Hedgeye CEO Keith McCullough developed during his years as a hedge fund manager and continues to refine. Nearly every trading day, you’ll receive Keith’s latest signals - buy, sell, short or cover.

[UNLOCKED] Fund Flow Survey | Gentlemen Prefer Bonds

Takeaway: Last week, investors sought safety in bonds, contributing a net $12.9 billion more to fixed income than equities


Editor's Note: This is a complimentary research note which was originally published January 14, 2016 by our Financials team. If you would like more info on how you can access our institutional research please email sales@hedgeye.com.


Investment Company Institute Mutual Fund Data and ETF Money Flow:

In the first week of 2016, investors reacted to the market turmoil by favoring bonds over stocks as measured by the -$12.9 billion spread between total equity flows and total bond flows (incorporating both mutual funds and ETFs). Positive numbers imply greater money flow to stocks with negative numbers imply greater money flow to bonds. With volatility on the rise in early 2016, we expect the aversion to stocks to continue.


Importantly, active domestic equity funds continued their losing streak, which we define as a string of outflows unbroken by four consecutive weeks of inflows. The following chart shows that domestic equity has been in outflow for 45 consecutive weeks with the current streak running at the fastest pace on record with a redemption average of -$4.0 billion per week. With the domestic equity exodus showing no sign of stopping, we continue to recommend a short position in shares of T. Rowe Price (see our TROW reports).

[UNLOCKED] Fund Flow Survey | Gentlemen Prefer Bonds - ICI19


In the most recent 5-day period ending January 6th, total equity mutual funds put up net outflows of -$2.4 billion, trailing the 2015 average outflow of -$1.5 billion. The outflow was composed of international stock fund contributions of +$1.6 billion and domestic stock fund withdrawals of -$4.0 billion. International equity funds have had positive flows in 41 of the last 52 weeks while domestic equity funds have had only 8 weeks of positive flows over the same time period.


Fixed income mutual funds put up net inflows of +$67 million, outpacing the 2015 average outflow of -$462 million. The inflow was composed of tax-free or municipal bond funds contributions of +$1.4 billion and taxable bond funds withdrawals of -$1.3 billion.


Equity ETFs had net redemptions of -$9.1 billion, trailing the 2015 average inflow of +$2.8 billion. Fixed income ETFs had net inflows of +$1.3 billion, surpassing the 2015 average inflow of +$1.0 billion.


[UNLOCKED] Fund Flow Survey | Gentlemen Prefer Bonds - 1 20 ICI1


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 2015 and the weekly year-to-date average for 2016:


[UNLOCKED] Fund Flow Survey | Gentlemen Prefer Bonds - ICI2


[UNLOCKED] Fund Flow Survey | Gentlemen Prefer Bonds - ICI3


[UNLOCKED] Fund Flow Survey | Gentlemen Prefer Bonds - ICI4


[UNLOCKED] Fund Flow Survey | Gentlemen Prefer Bonds - ICI5


[UNLOCKED] Fund Flow Survey | Gentlemen Prefer Bonds - 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.


[UNLOCKED] Fund Flow Survey | Gentlemen Prefer Bonds - ICI12


[UNLOCKED] Fund Flow Survey | Gentlemen Prefer Bonds - ICI13


[UNLOCKED] Fund Flow Survey | Gentlemen Prefer Bonds - ICI14


[UNLOCKED] Fund Flow Survey | Gentlemen Prefer Bonds - ICI15


[UNLOCKED] Fund Flow Survey | Gentlemen Prefer Bonds - ICI16


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 2015, and the weekly year-to-date average for 2016. In the third table are the results of the weekly flows into and out of the major market and sector SPDRs:


[UNLOCKED] Fund Flow Survey | Gentlemen Prefer Bonds - ICI7


[UNLOCKED] Fund Flow Survey | Gentlemen Prefer Bonds - ICI8


Sector and Asset Class Weekly ETF and Year-to-Date Results: In sector SPDR callouts, investors shunned technology stocks, redeeming -$506 million or -4% from the technology XLK ETF.


[UNLOCKED] Fund Flow Survey | Gentlemen Prefer Bonds - ICI9


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.


[UNLOCKED] Fund Flow Survey | Gentlemen Prefer Bonds - ICI17


[UNLOCKED] Fund Flow Survey | Gentlemen Prefer Bonds - ICI18


Net Results:

The net of total equity mutual fund and ETF flows against total bond mutual fund and ETF flows totaled a negative -$12.9 billion spread for the week (-$11.5 billion of total equity outflow net of the +$1.4 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 +$691 million (more positive money flow to equities) with a 52-week high of +$20.5 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.)


[UNLOCKED] Fund Flow Survey | Gentlemen Prefer Bonds - ICI10


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:


[UNLOCKED] Fund Flow Survey | Gentlemen Prefer Bonds - ICI11


HedgeyeRetail (1/20) | KSS/JCP Searching for Growth

Takeaway: KSS spending up for the Oscars to attract new customers, won't find 'em. JCP trying appliances, worth a shot.

KSS - Spending up to take JCP's spot as sponsor of the Academy Awards.



KSS can spend up to unseat JCP as the department store sponsor of the Academy Awards, to 'introduce the Kohl's brand to new customers'. But, the fact remains that KSS has tapped over 75% of its potential customer base. Based on our calculations, KSS already attracts ~65mm of its 82mm potential customer base to its stores every year.  We can assure anyone that the last 25% costs a lot more to acquire than the middle 50%.

HedgeyeRetail (1/20)  |  KSS/JCP Searching for Growth - 1 20 2016 chart1


JCP - J.C. Penney to do appliances for 1st time in 30 Years. Worth a shot.



Despite our initial reaction, this doesn't seem like such a bad idea. SHLD is in consolidation mode, and there is market share for the taking because of this. Is it the right medicine for a home department that was responsible for a third of the $5.9bn in market share the retailer coughed up from 2010-2013. We're not sure yet, but here are a few things to consider.


1. JCP is being prudent in its test, tapping only 22 markets.

2. The retailer will rely on drop-shipping from the manufacturers, which solves the inventory and fulfillment problems, the headline immediately raised. Fact is that there is a lot of unproductive space in JCP's fleet with store productivity at $120/sq. ft. at the bottom of the barrel in its competitive set. With most of its real estate securitized, breaking apart real estate isn't a good option. So, why not appliances?


WMT - Wal-Mart cancels plans for 2 new supercenters in poorer D.C. areas -- D.C. officials upset after allowing Wal-Mart to open 3 stores in the city's more affluent sectors



AMZN - Amazon strikes unprecedented deal with USPS -- sellers will see no rate change on the cost of Priority Mail shipping, which will remain at 2015 rates



NKE - Nike  celebrating the Super Bowl's 50th anniversary with Gold Collection and the Super Bowl 50 Nike Speed Destroyed Collection

HedgeyeRetail (1/20)  |  KSS/JCP Searching for Growth - 1 20 2016 chart2



NKE - Nike & The University Of Illinois Sign 10-Year Contract Extension



NKE - Nike surprises by sponsoring snowboarders after discontinuing its snowboarding and skiing gear in Fall 2014



GCO - BSN SPORTS Acquires Lids Team Sports From Genesco Inc.



HD - Home Depot replacing head of U.S. stores Marc Powers with longtime company veteran Ann-Marie Campbell



AMZN - Amazon's Dash Replenishment Service going live, which enables connected devices to automatically order physical goods from Amazon when supplies are running low



AMZN - Amazon hiring 1,200 for new robot-reliant 800,000 sq-ft warehouse



CHS - Chico’s FAS sells Boston Proper women’s apparel business to LA-based private equity firm.



AAPL - Apple, which currently sells through local Indian distributers, is seeking Indian government approval to open retail stores



LZB - La-Z-Boy Inc. appoints Giant Eagle exec  James Chickini as VP of real estate



M - Macy's announces plans to open 93,000 sq-ft Bloomingdales store in Kuwait in 2017



SWHC - Smith & Wesson, the largest U.S. firearms maker, announces place to buy its way into the outdoor sporting-goods market


Shelter From The Storm: A Winning Hedgeye Call In The Market Bloodbath

Takeaway: Once again, it has paid to stick with Hedgeye's non-consensus process.

Shelter From The Storm: A Winning Hedgeye Call In The Market Bloodbath - z re dd


Amidst the sea of red across global markets this morning, precious few investments are offering investors shelter from the storm. Moreover, ever fewer are actually up for the year. One of those just happens to be our macro team's favorite contrarian idea. It is paying off big.

Long Bonds (TLT)


For the record, the S&P 500 is down 8% year-to-date, while TLT is up 4%. 


Shelter From The Storm: A Winning Hedgeye Call In The Market Bloodbath - TLT cartoon 01.26.2015


Here's analysis from Hedgeye CEO Keith McCullough this morning:


"The UST 10YR is punching in at 1.96% this am, doing its job for us (favorite idea is Long the Long Bond) as both #Deflation and #Recession expectations continue to get priced in – Yield Spread (10s/2s) at 114bps hits new cycle lows; staying short the Financials (XLF) as JPM, BAC guidance sounded like the Fed’s (lala land) relative to economic reality."




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