The Economic Data calendar for the week of the 1st of February through the 5th of February is full of critical releases and events. Here is a snapshot of some of the headline numbers that we will be focused on.
Takeaway: Current Investing Ideas: TIF, JNK, NUS, W, FL, WAB, MDRX, ZBH, FII, XLU, MCD, RH, GIS & TLT
Below are our analysts’ new updates on our fourteen current high conviction long and short ideas. Hedgeye CEO Keith McCullough’s updated levels for each ticker are below.
Trade :: Trend :: Tail Process - These are three durations over which we analyze investment ideas and themes. Hedgeye has created a process as a way of characterizing our investment ideas and their risk profiles, to fit the investing strategies and preferences of our subscribers.
After a busy week of domestic data, you probably don’t need us to tell you that growth continues to slow. Despite the short-covering squeeze in energy stocks, Utilities (XLU) closed out January as the only sector in positive territory (+5%), other than Consumer Staples which eked out a +0.5% gain. It was an awful start to the year for the S&P 500 (-5%).
Don’t expect +10% of relative outperformance every month, but if you stuck with us on this trade, you’re in much better shape than most. Below is both absolute and relative sector performance for the S&P 500 for January:
Looking at our pair trade in credit markets, Long-Term Treasuries (TLT) continues to preserve capital against the slow-moving trainwreck in Junk Bonds (JNK). Week-over-week, 10-year bond yields crashed 13bps to 1.92%. That helped lift the best play on U.S. growth slowing (TLT) by 0.85% on the week as credit spreads continued to widen (JNK gained +0.76% on the week, underperforming TLT marginally on a relative basis).
Meanwhile... the market didn’t believe the FOMC's steadfast forecast on Wednesday that there will be four rate hikes in 2016. The “0” in front of Q4 GDP confirmed that all is NOT well. The bid-yield of December 2016 Federal Funds Futures (rate hike expectations) agrees with our #GrowthSlowing call.
As the chart below shows, the market questions the credibility of the December rate hike, with December 2016 Fed funds futures crashing to new lows on Friday’s GDP report. Clearly, investors don't believe the economy is in any shape for tighter policy.
Getting past Old Wall storytelling, let's look at the increasingly deteriorating data. Here’s how things shook out through the end of this week:
To view our analyst's original report on Allscripts Healthcare Solutions click here.
All evidence suggests that attrition continues to be an underappreciated risk by Allscripts Healthcare Solutions (MDRX) investors. The latest data point came from MidMichigan Health, who announced earlier this week that they signed a $55 million contract with Epic for a system-wide, integrated EHR. The expected go-live date is April 2017.
MidMichigan is affiliated with the University of Michigan Health System (Epic Shop), and operates 4 hospitals with approximately 500 providers. MidMichigan currently uses Cerner in the hospitals and Allscripts Touchworks in the medical practices (approximately 200 employed physicians).
Allscripts also had an arrangement whereby MidMichigan would subsidize the cost of the EHR to affiliated, independent physicians with referring privileges to the hospital. As a result, the loss likely extends beyond that of the employed physicians and is consistent with our 'reverse network effect' view.
To view our analyst's original report on Nu Skin click here.
NUS IS A BROKEN BUSINESS MODEL
Nu Skin (NUS) is down roughly -16.5% YTD, leaving people asking how much lower can it go? We think the name has significant downside from here.
Some of the bear case is dependent on government action and predicated on the allegation that they are deceiving consumers and performing fraudulent acts.
However, even if you're willing to take the other side of that trade and say they are completely ethical and not doing anything illegal, their business is still in a secular decline, boasting minuscule market share in the category.
Other issues? The implications of slowing distributor growth will be a serious problem for them, and attempting to sell high-end, over-priced products in the cold calling, direct selling environment will prove fruitless in the long run.
Bottom line: Even after the recent selloff, we see an additional 30-50% of downside.
To view our analyst's original report on Federated Investors click here.
The deluge of asset management earnings that hit during the week is always an exercise of parsing words and figuring out the many machinations affecting the industry. The basic premise of the sector’s results however were quite clear and, as a result, Federated Investors (FII) is starting to outperform.
Money market fund balances are starting to improve as investors rush back into cash. Also, on the recent Fed rate hike, there was marginal improvement in the profitability of money funds.
FII on both a top line revenue and bottom line earnings perspective handily trounced the rest of the group with +21% year-over-year earnings growth on +12% top line revenue growth. FII will continue this outperformance into the 1H of 2016.
To view our analyst's original report on Wabtec click here.
With speeds picking back up, we expect that equipment to be pushed back out. More speed results in less equipment in service. If speeds continue higher, freight railroads may find themselves with ample excess equipment and reduced aftermarket needs amid slow volume growth – a negative combination for Wabtec (WAB).
We believe freight rail equipment spending is just starting to enter a multi-year downturn. It’s a cyclical market, and WAB shares remain priced for growth. As for WAB and any cyclical company, peak margins aren’t a great sign for longs.
To view our analyst's original report on Tiffany click here.
Late last week Tiffany's (TIF) board approved an expanded share repurchase program. We're not concerned about being short TIF into the company re-upping its share repo authorization. Here's why:
The fact is that some companies, like GPS (which we also don't like) use repurchases as an offensive weapon – cutting its share count in half over a decade. TIF is not one of those companies – as it basically uses the repo program as a way to offset dilution from options and other non-cash compensation.
To view our analyst's original report on Wayfair click here.
This week Wayfair (W) put out a press release regarding a new search engine platform it is implementing in Europe. The company continues to invest in infrastructure both domestically and abroad, while the business model has yet to prove it can be profitable at scale.
We think the company is massively overestimating its addressable market when it notes a $90bn and 60mm household opportunity in the United States. Our math suggests a number less than a third of that. We suspect management is overestimating the international opportunity as well.
To view our analyst's original report on Restoration Hardware click here.
Here are the key takeaways from a call our Retail team hosted this Wednesday titled: RH | In a Recession…
Restoration Hardware (RH) will absolutely play offense:
Recession or not, we think management will run the company like it’s in one. That means RH is likely to be more aggressive on price to gain share. RH does not like playing defense, and we think it’s comfortable taking an offensive margin hit to gain share. That said, it has some defendable financial levers that were 100% absent in past downturns. We think the limited earnings downside in a recession will surprise most people.
LT Risk reward skewed grossly to the upside:
Even in a Great Recession 2.0, RH is likely to grow revenue by 5-10%, which is huge given the rest of the category would be down 20-30%. That bifurcation is likely not recognized by the market. Realistically, in a ‘normal’ recession (whatever that is) revenue is up double digits, and earnings temporarily bottom out at $2.65. Could we see 18x that number? That’s $48, or $13 down. Upside in a year in a normal economy is about $120 – or roughly 2x today’s price.
To view our analyst's original report on McDonald's click here.
If you weren’t yet convinced that Steve Easterbrook is leading the turnaround of the McDonald’s business, it is time to start believing. Since Steve stepped into his current role as CEO 12 months ago, McDonald's (MCD) has orchestrated an historic turnaround of their global business. The success they are now seeing is built up by dozens of relatively minor improvements across the system, as well as bigger initiatives that changed MCD’s offerings and the way they conduct their business.
Coming out of this quarter we are very encouraged by the progress they are making across all markets, most notably in the United States. In 4Q15 the U.S. segment comp store sales increased +5.7% versus consensus estimates of +2.7%, a 300 bps beat. These results were primarily driven by strong consumer demand for All Day Breakfast and mild weather compared to last year. These factors brought in traffic, while the changes MCD made to its restaurants (improved food and better customer experience) will keep these customers coming back.
The job is not done yet, and Steve was quick to share this same sentiment.
“While we are pleased with the recent positive momentum in the U.S., it will take at least six more months of positive comparable sales and guest count growth to progress through sustained and prolonged growth phases of our turnaround.”
We have seen two quarters of strong growth, but the team at MCD must continue to stay focused on further refinements and innovation to propel continued growth for the future.
Looking out into 2016, MCD has strong tailwinds; three more quarters before they lap the All Day Breakfast launch in the U.S., a full year of McPick 2, their mobile app is gaining steam, and they continue to improve their domestic system, with goals to perform 400 to 500 reimages in 2016 (about half of the system is modernized in the U.S. currently, MCD has set a global goal of having 90% of restaurants modernized by the end of 2018). For all these reasons and more, MCD continues to be our top LONG idea in the restaurant space.
In closing Steve provided positive commentary for the outlook of 2016:
“I am confident in our ability to sustain our positive momentum as we continue to execute our turnaround plans into 2016. And I’m excited about our longer-term opportunities to strengthen our business and reassert McDonald’s as the global leader we know we are.”
To view our analyst's original report on Foot Locker click here.
Earlier this month The Finish Line (FINL) announced that it would be closing 25% of its existing fleet over a 4 year time period. That’s gross closures, as the company will be working on the quality of its real estate portfolio to increase its penetration in better quality malls, i.e. more overlap with Foot Locker (FL) in better markets.
What we know – each of the 150 stores earmarked for closure are doing about 1mm bucks per store, about 50% below the company average of $2mm. 65% of those sales are attributed to FINL loyalty members.
If we look at the store footprint overlap by mall between Foot Locker (banner) and Finish Line it’s only 67% (chart below). And our sense is, there is more overlap on the top end of the spectrum compared to the bottom end where FINL will be closing locations. That’s because FL has been extremely prudent over the past 5 years as it stripped capital out of the model by rationalizing its store footprint.
All in we get to a $0.03 benefit to FL’s bottom line, and $20mm to the top line per year through FY19 from the door closures assuming a high overlap ratio between the store locations. That's less than 1% accretion per year. To get there we assume that FINL recaptures 40% of the lost sales, and 80% of the forfeited share shifts over to FL. We assume a 30% margin for dollars transferred, as FL won’t have to spend up dramatically to win that money.
Worst case, assuming FINL recaptures 0% of the dollars lost, and FL gets 100% (ain’t going to happen as NKE pushes its direct-to-consumer agenda), we could see a $40mm benefit to the top line and $0.06 on the bottom about 1.5% of earnings growth.
To view our analyst's original report on Zimmer Biomet click here.
Pricing may be getting less worse on a reported basis, but share loss, Medicare mix, and a slowing market continue to be bigger and largely unanticipated risks going forward. Zimmer Biomet's (ZBH) Q415 earnings release and call revealed as much.
The market (and us) were looking for a better result on the topline, but it appears demand slowed modestly in the fourth quarter overall, while both SYK and JNJ outperformed ZBH. ZBH cited dealer issues in Europe as well as southern European and Emerging Market growth problems, the latter echoed by other med tech earnings releases, both of which will take some time to resolve.
The next couple of weeks will be informative as we get both Healthcare employment and job openings in Healthcare from the BLS. Today CMS updated Medicaid enrollment through November.
Altogether we will have a complete update for our #ACATaper theme which has so far slowly been panning out, but that we expect to accelerate to the downside in the next 2 months, and bring with it some additional pressure on ZBH’s already modest topline expectations.
Click here to watch a video of our Healthcare team's latest updates on Hospital Corporation of America (HCA), Hologic (HOLX) and Zimmer-Biomet (ZBH).
General Mills (GIS) remains one of our top Long ideas in the consumer staples space. As we have continued to say it boasts style factors that are ideal in turbulent times; high market cap, low beta and liquidity.
Recently, General Mills has been attacked by Chobani commercials, claiming that Yoplait yogurt contains the same ingredients used in pesticide. GIS filed a false advertising lawsuit against Chobani demanding that they stop showing that commercial because it could be detrimental to sales. GIS just got word that a federal judge has barred Chobani from continuing the ad campaign.
This is a win for GIS, but it is unclear right now if there was any damage done to the brand. At this time we do not believe it had any serious impact on the company. We will keep you informed of any material information regarding this lawsuit as it moves forward.
Takeaway: Domestic capital markets continue to perfectly price in our forecasted GIP Model quadrant for 1Q16 (i.e. #Quad3 stagflation).
Earlier this evening, we received the following question from a very thoughtful [and successful] investor in response to our deep dive on Q4 2015 and full-year 2016 GDP:
"What are the sectors that outperform and underperform in quad three? Quad four?"
Given it's obvious relevance and our interest in continuing to broadly own the U.S. capital markets debate, we thought we'd share our response with a broader audience:
Thanks for reaching out; hope all is well, good sir.
In #Quad3, the sectors that have historically performed best are Utilities, REITS and Tech – in order from best to least best:
The sectors that have historically performed most poorly in #Quad3 are Materials, Financials and Consumer Discretionary – in order from worst to least worst:
In #Quad4, the sectors that have historically performed best are Healthcare, Consumer Staples and Consumer Discretionary – in order from best to least best:
The sectors that have historically performed most poorly in #Quad4 are Energy, Financials and Materials – in order from worst to least worst:
The table below details the breadth of our factor exposure backtest data according to the respective GIP model quadrant:
With 2016’s first month of PnL officially in the books, we are keen to highlight how domestic capital markets continue to perfectly price in ongoing #Quad3 stagflation.
Within the equity market specifically, Utilities, REITS and Tech are all outperforming the broader market by an equally weighted average of 424bps. Meanwhile, Materials, Financials and Consumer Discretionary are each underperforming the broader market by an equally weighted average of 327bps. The delta between our [only] preferred equity sector on the long side (i.e. Utilities) and our most preferred equity sector on the short side (i.e. Financials) is a whopping 1380bps. That is a ton of alpha without having to take on any market risk.
Within fixed income specifically, our call to aggressively high grade bond portfolios is paying off as well. Our favorite long idea in the space (i.e. 30Y Treasury Bonds) is outperforming our favorite short idea (i.e. High Yield Credit) by 1049bps YTD already. Muni Bonds are delivering solid absolute and relative performance as well.
All told, accurately forecasting directional trends in top-down growth and inflation readings continues to deliver a substantial degree of alpha for investors who are appropriately positioned for our forecasted quadrant outcomes. More importantly, we expect this #Quad3 divergence trade to continue for the next month or two. By mid-to-late March, however, the market may have begun to price in the economy’s inevitable shift back to #Quad4.
Will Healthcare and Consumer stocks be as defensive as they have historically been in #Quad4 during the next iteration (2Q16)? Per the hyperlinked research below, the fundamentals would suggest the answer to that question is a resounding “NO”. That said, however, the confluence of time and price will ultimately reveal the truth as it always does.
Hope this helps; let me know if I can expound upon or add anything. See you in a couple of weeks!"
Enjoy your respective weekends,
“I would guess we're going to see more Chinese investment in the United States in all kinds of things… But it wouldn't surprise me to see some of that, yeah. I expect that's probably a strategy. If I were sitting over there in China, I'd be looking at some of this also.”
- CAT CEO Doug Oberhelman on Zoomlion TEX 1/28/2016
Takeaway: As we see it, MTW offers favorable idiosyncratic exposure in a deteriorating macroeconomic environment, with the less cyclical Foodservice equipment unit dominating the value picture. The Street’s approach to the Crane segment is inconsistent, as the fixation on the unit’s cyclicality stops at valuation. While we plan to keep our view on a short leash in anticipation of a weakening operating environment, the new management team performed extremely well on today’s call and looks to be executing well.
We will let others summarize the quarter, and really only want to highlight a few items. Our key work on MTW is in our December Black Book and Model/EQM – ping us if you would find them helpful.
Cranes Segment Is Cyclically Depressed: It is odd how analysts bemoan the Crane business as too cyclical for debt, but fail to treat the business as cyclical for valuation purposes. Cyclicals look expensive near a trough, and cheap near a peak. It is a real challenge and a real alpha opportunity. An investor that uses a multiple of an income metric to invest in cyclicals will bias toward purchasing value traps and passing on real value. Crane segment margins are already below GFC levels on a TTM basis. Part of that is mismanagement, but crane demand also tanked last year as used resource-related cranes displaced new sales. Note that Crane segment margins did fine during the strong dollar period of the 1990s, to the extent comparable.
Crane Valuation: We would instead choose a sales based multiple for the Crane segment. Historically, TEX and Tadano have both traded between 0.5 and 1.5 EV to sales. The Zoomlion bid for TEX comes out to roughly 0.71. If one uses that bid as reference point the Crane segment would be worth ~$1.3 billion. We can take it out, say, $200 million in separation and other one-time costs and still be left with a Crane EV of $1.1 billion. There is significant room for operating improvements, too.
Foodservice Availability Bias: Shares of MIDD have sold-off, which has reduced the valuation on the most ‘available’ comparison. Comparable transactions, like Marmon’s buy of IMI’s beverage segment, haven’t changed; shares of Rational AG, a European comp, have increased. We still think its worth as much or more than MTW’s current EV, say, >$3.5 billion.
Upshot: As we see it, MTW offers favorable idiosyncratic exposure in a deteriorating macroeconomic environment, with the less cyclical Foodservice equipment unit dominating the value picture. The Street’s approach to the Crane segment is inconsistent, as the fixation on the unit’s cyclicality stops at valuation. While we plan to keep our view on a short leash in anticipation of a weakening operating environment, the new management team performed extremely well on today’s call and looks to be executing well.
Takeaway: We reiterate our #USRecession and #CreditCycle themes in the context of the latest data -- namely Q4 GDP.
Earlier today, we received the following question from a very thoughtful [and successful] investor:
"So what are your quarterly GDP estimates for this year, and will we see a negative print and/or two quarters of negative growth? I appreciate that it is somewhat irrelevant if we have a technical recession by definition, but you guys are making the recession call, no?"
Given it's obvious relevance and our interest in continuing to broadly own the U.S. economic debate, we thought we'd share our response with a broader audience:
Regarding your question on when, where and how a recession will occur in our U.S. GDP model, it’s important to note that it’s impossible to model in negative GDP prints from where U.S. economic growth is tracking currently – either econometrically or quantitatively.
Our #LateCycle view that has since morphed into our #USRecession and #CreditCycle themes has always been centered on the high and, most importantly, rising probability of a recession commencing in/around mid-2016. It’s not about ascribing a round (or not-so-round) probability estimate to that [broadly undesired] outcome. It’s actually about whether investor, business and/or consumer expectations for an outright recession are rising or falling.
And much like expansions on the way up, a rising probably of recession is reflexive on the way down from the peak in economic growth. Recall that those peaks occurred in 2H14 for manufacturing and capex growth and in 1H15 for consumption and employment growth, respectively.
Modeling in a U.S. recession would be like modeling in +1% revenue growth for AAPL at this time last year – which would’ve obviously been too far out of the band of probable outcomes for even the most ardent bear. The point of our Bayesian inference modeling process is to constantly shock our GDP and CPI models with relevant Bayes factors (i.e. high-frequency economic and financial market data) in order to appropriately adjust our estimate from the reported base rate as implied by the base effects themselves, as well as per trends in high-frequency economic data.
What we’ve learned from Dr. Daniel Kahneman’s work on Prospect Theory is that the market prices in those adjustments (i.e. rates of change) from the base rate, rather than the final outcomes (i.e. absolute states). As such, we don’t start with a desired outcome (i.e. “GDP feels like it’s going to be 3-4%”); we let the data guide our forecasts higher or lower – purely in differential terms.
It sounds overly complicated, but we can assure you it really isn’t; it’s just overly differentiated from competing GDP and CPI models. How we model the economy is not at all unlike how any good bottom-up investor would model a company.
So to answer your question(s) specifically:
All told, we reiterate our #USRecession theme in the context of the latest data. Our refreshed U.S. GIP model, GDP and economic summary tables are below. Feel free to email with any follow-up questions."
Have a great weekend,
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