The Economic Data calendar for the week of the 22nd of February through the 26th 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, DRI, NUS, W, FL, WAB, MDRX, ZBH, XLU, MCD, RH, GIS & TLT
Below are our analysts’ new updates on our fourteen current high conviction long and short ideas. As a reminder, if nothing material has changed in the past week which would affect a particular idea, our analyst has noted this. Hedgeye CEO Keith McCullough’s updated levels for each ticker are below.
Please note that we added Darden Restaurants (DRI) to the short side of Investing Ideas this week.
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.
Long-Term Treasuries (TLT) and Utilities (XLU) remain our two best fixed income and equity vehicles to play #Lower-For-Longer on growth and interest rates as the market gets more and more skeptical about the central bank dogma.
Over the past week we’ve heard central bank cowbell across the globe. First came BOJ members calling for “greater cooperation among G7 partners in order to ‘soothe’ market jitters.” Then ECB members chimed in saying the “ECB is ready to do its part.”
Wednesday? More of the same from the Fed. In the FOMC minutes release, we heard that inflation was expected rise to two percent "over the medium term," accompanied by a gradual rise in policy interest rates…
If you’ve watched markets recently, they no longer believe in the central planning hoopla. The NIKKEI failed to hold its short-lived gains and the yen went up on the week, not down despite the sound of monetary cowbell. Meanwhile, the Euro went up on the week, not down despite verbal devaluation.
With the market losing faith in the central planning policy backstop, investors continue to yield to top-down market signals and the direction of the data. To be clear, the data continues to deteriorate and volatility continues to break-out.
The yield spread (10-year Treasury yield minus 2-year Treasury yield) has compressed 24 basis points this year, and TLT is up 8.6% vs. the S&P 500 which is down -5.2%. The December Federal Funds Futures contract has declined in a straight line since December’s rate hike.
This implies that the probability that the Fed continues to hike rates has gone from likely to zilch. That's what the bond market and federal funds futures market are telling us about the preponderance of growth slowing data points. Take this week's Industrial Production. It declined for the 3rd consecutive month on a Y/Y basis in January (see chart below).
With market turmoil, the Junk Bond ETF (JNK) is down -4.5% vs. the defensive, growth slowing equity sector Utilities (XLU) which is up 6.7%, outperforming the S&P 500 by 12.9% on a relative basis. That’s yet more confirmation of our dour economic outlook economy (spreads widen in tumultuous market environments and Utilities are a defensive sector that outperforms when growth is slowing). Take our advice, and stick with allocations that have worked: Long TLT, XLU; Short JNK.
To view our analyst's original report on Allscripts Healthcare Solutions click here. Below is a brief excerpt from an institutional research note written by Hedgeye Healthcare analyst Tom Tobin following Allscripts earnings release on Thursday.
MDRX | INITIAL THOUGHTS ON 4Q15 EARNINGS AND 2016 GUIDANCE
Bottom Line: MDRX provided disappointing 2016 sales guidance and bookings growth will likely to go negative in 2H16. We continue to see downside < $10.
To view our analyst's original report on Nu Skin click here. Below is a brief institutional research note written by Consumer Staples analysts Howard Penney and Shayne Laidlaw.
NUS | CHANGING THEIR LANGUAGE…AGAIN
Nu Skin (NUS) reported 4Q15 and full year 2015 results on February 11th that missed consensus numbers by a long shot. What was even worse, was their guide down for 2016. (Click here to read last week's Investing Ideas earnings update on NUS.)
The reason for this note is to report additional disclosure that we found in their 10-K filed this morning. The fact that the SEC is investigating NUS for actions in China, specifically regarding charitable donations is not new. But the increased disclosure around subpoenas being served and employees being questioned by the SEC is. Below is a statement from their risk factors in their 10-Q filed on 5/6/15, and then their risk factors reported in the most recently filed 10-K.
As the SEC continues to peel back the onion, we do not know what else they will find. There is no definitive conclusion to be made from this, but the increased interest from the SEC is not good news for the company.
We continue to see significant downside in the stock.
To view our analyst's original report on Wabtec click here. Below is a brief excerpt from an institutional research note written by Hedgeye Industrials analyst Jay Van Sciver following Wabtec's earnings this week.
ORDERS, NOT SALES:
Looking past the headlines, the internals of yesterday’s report from Wabtec (WAB) continue to point to 2016 EPS well below $4.00. We don’t think that the 2016 guide from WAB makes sense, beyond what we expect is management’s desire to see a higher share price to appease a potentially disgruntled Faiveley family.
The company met estimates in 4Q15, but drained the backlog of orders from earlier periods to do so, as Freight orders were ~20% below reported sales. While we need the 10-K for a proper analysis given WAB’s skimpy disclosure, the implied orders, aftermarket sales, and PTC trends look pretty negative to us. The big picture of rail equipment capital spending rolling over from a significant long-term up cycle remains intact.
To view our analyst's original report on Tiffany click here.
Tiffany (TIF) declared its quarterly dividend this week. It was kept in line with last quarter at 40 cents per share.
The company has seen record operating cash flow over the last 4 quarters. However, the cash generation has not been from improving operations, but rather management de-risking the balance sheet, which may be driven by the negative economic outlook.
Tiffany has a cash conversion cycle of about 470 days, among the highest you can find in retail. It makes sense that the company would be cautious about building working capital in the face of an increasingly volatile economic environment.
To view our analyst's original report on Wayfair click here.
A Portland, Maine local newspaper reported this week that Wayfair (W) is planning new sales and customer service offices in Brunswick and Bangor, Maine. The company is planning to hire up to 950 employees, that equates to a 30% increase from the ~3,170 they had at the end of 3Q15.
Not the traditional talent hotbed, our sense is that Wayfair is getting a good real estate deal while recognizing lower competitive compensation rates vs its HQ in downtown Boston. Management had guided to accelerated hiring on the last conference call to catch up with growth.
This is yet another example of Wayfair investing in the infrastructure to service an addressable market that we think will be way below the company’s expectations.
Next week we will have thoughts on Wayfair’s 4th quarter earnings release as the company reports on Thursday. Stay tuned.
To view our analyst's original report on Restoration Hardware click here.
Last week Restoration Hardware (RH) secured an anchor lease in San Francisco's planned Pier 70 shopping center. This is a typical RH maneuver in its backyard of SF. Taking a Flagship spot in a new redevelopment, while being one of the first retailers to sign on the dotted line. That leads to below market rents in an up-and-coming retail space, which allows the landlords to attract the right type of co-tenants with RH as the anchor.
To view our analyst's original report on Zimmer Biomet click here.
We have no update on Zimmer Biomet (ZBH) this week but Hedgeye Healthcare analyst Tom Tobin reiterates his short call. Hedgeye CEO Keith McCullough offered up his own thoughts upon issuing a "sell signal" on ZBH in Real-Time Alerts Thursday:
"I have a very long list of high quality short ideas. As I explained in RTA Live yesterday, some of the happiest hunting grounds for short are where there are still the most bulls left:
2. Consumer Discretionary
Since all 3 of these Sector Style factors are bearish on both my TRADE and TREND durations, all I have to do from there is ask my analysts for the best shorts within these sectors. Zimmer continues to be one of them.
Zimmer Biomet (ZBH) should have continued issues in Europe and worsening conditions in the US as we progress through the year. The stock price definitely incorporates some of the weakness, but as of yet, not enough.
Are you Bearish Enough?
To view our analyst's original report on McDonald's click here.
No update on McDonald's (MCD) this week from Hedgeye Restaurants analyst Howard Penney. MCD continues to outperform. It's up 17% since the fast-food company was added to Investing Ideas in August, versus -8% for the S&P 500.
To view our analyst's original report on Foot Locker click here.
Foot Locker's (FL) big capital spending plan announced this week is anything but good for the financial return profile, and the stock. The company’s capex number for the upcoming year is expected to clock in at $297mm. That’s the most FL has spent since 1999, and it represents a 26% increase from the already-elevated levels we saw in 2015.
As context, our extremely negative long-term view on FL is predicated upon an unsustainable financial model, and a mismatch between how much FL is spending on both the P&L (SG&A) and on PP&E to drive the business forward in a changing footwear retail selling model.
This stock will be choppy quarter to quarter. But last we checked, stocks don’t go up when financial returns get cut in half.
Next week we will have thoughts on Foot Locker's 4th quarter earnings release as the company reports on Friday.
General Mills (GIS) is a large player in the Yogurt category with their Yoplait brand. Their competitors, Dannon, Chobani and Fage have been aggressive on merchandising and consumer spending, making it difficult to compete while maintaining internal margin objectives. GIS is turning on innovation with the growth of Annie’s yogurt and that should help the trajectory of the business. Yogurt being a roughly $1.4 billion business, turning it around is a top priority for management.
On the broader GIS long thesis, it's unlikely that the stock is going to go up 20% in the next year, but we do believe it will fare better than most in the consumer staples sector, especially as we head into an economic slowdown.
We added Darden Restaurants (DRI) to the short side of Investing Ideas this past week. Click here to read our analyst's full stock report.
Takeaway: There is absolutely no reason to own JWN today at this price. But it's equally as difficult to short.
This JWN print followed the road map we expected. Weak quarter followed by a guide down for 2016. The 8% sell-off afterhours isn’t enough to get us more excited about this name as a long -- and quite frankly, we'd be surprised if it closed down that much tomorrow.
If anything the print raised more questions than it answered. Primarily around the comp trajectory at Rack and the viability of the non-core businesses. The earnings drivers in the core are in place as JWN emerges from ‘investment mode’ in the second half of 2016. Especially if at that time we're in the midst of better consumption growth (we're not banking on it). Until then, we're comfortably on the sidelines. At this price, this is pretty much a 'do nothing' stock.
What We Liked:
1) Comps: The topline actually held up relatively well accelerating on a 1 and 2yr basis sequentially despite the macro backdrop. There are puts and takes across the business – one being the -3% comp at Rack, the worst comp in its history. At the same time, e-comm growth in the off-price channel accelerated by 500bps to 51% YY. That of course comes with an offset lower on the P&L, as the company bought the comp with gross margins down 184bps in the quarter – the biggest hit to GM since 1Q09. We’re generally encouraged by the fact that JWN performed as well as it did with the rest of the Department store space cracking.
2) Lower capital intensity/cost rationalization: Now out of the peak investment year, we already knew that CapEx was coming down from elevated levels, but the company slashed its five year target by another $300mm. We expect that to come down even more from here evidenced by the fact that the Rack launch into Canada (first store opening date announced earlier this week) was pushed back a year to 2018. On the SG&A side, management talked to a $100mm cut in SG&A spending. It’s hard to give that a lot of credence without more detail, but it’s an encouraging change on the margin given JWN’s propensity to spend.
3) Guidance: Tough to see a 9% earnings guide down as a positive, but expectations headed into 2016 were overly bullish especially in 1H in light of the current state of consumer demand. No question that street models are coming down considerably from current levels after this print. But, the drivers for a positive change in the earnings trajectory are in place in the 2nd half of 2016.
What We Didn’t Like:
1) Nordstrom Rack Performance: As noted earlier, this was the worst quarterly performance from the concept, EVER. It comes as no surprise that we’ve seen a bifurcation in B&M comp trends at the same time off-price online is growing like a weed. The question that we have to answer is, will e-commerce continue to dilute the Brick and Mortar business? If so, we are looking at lower profitability across the board. Given that much of the valuation premium for JWN to its peer group is predicated on square footage growth (i.e. viability of the brick and mortar Rack business), this comp number will only stoke the concerns about a) the 300 store target and b) the viability of the business model.
2) Inventories: JWN already took it on the chin on the gross margin line, not once but twice over the past two quarters, and the current inventory position is still out of whack. That will lead to additional gross margin pressure in the first half of the year as the sales outlook is less than optimistic.
3) Canada/Trunk dilution: Management conveniently lumped in the dilution from off-price into is calculation of the dilution from ‘non-core’ this quarter, but based on our best measurements of the bar chart we get to dilution of $62mm and $64mm from Trunk and Canada, respectively. Collectively that’s a $126mm hit to EBIT, a far cry from the $56mm guided to on the 3Q call. Some of the Trunk dilution is due to acquisition costs in FY15, but the outlook for ’16 is for another $30mm-$40mm of dilution for a business that was ‘break-even’ when JWN acquired it. On the Canada front, a boat load of capital has been allocated to setting up operations North of the border, with the outlook for $1bil in sales by 2020. We don’t think Nordstrom Canada will get there by then because of the productivity premium we’d have to assume (about 35%+ in the full line business) to get to that number. There is enough leverage for this model to work to offset about $50mm in dilution by 2017, but we need to see a positive inflection in the EBIT trends, starting now in order to get more positive.
Our note from earlier this week...
02/17/16 02:56 PM EST
JWN | TIME VS. PRICE
Takeaway: When we finally get a glance of JWN’s sales numbers–they need to be truly horrendous. We’d actually look to buy it on a sell-off tomorrow.
Conclusion: This is a multi-duration call. Bearish over the near-term as macro headwinds put earnings at risk. But, levers are there once the consumer stabilizes/recovers. The reality is that this is the only department store that really needs to exist.
We assembled a rather hefty slide deck on JWN as it emerged as a battleground stock ahead of this week’s print. Initially, we were very bearish. The precipitous increase in short interest from 6% to recession levels of 20% over the past month means that when we finally get a glance of JWN’s sales numbers – they need to be truly horrendous. By the look of its e-commerce business, that’s precisely what we’ll get. Sometimes, the consensus is right, and this time, it probably is.
Unfortunately, it’s still the consensus. And while we think that this quarter will be terrible. The rate of change on the sales, gross margin, sg&a, and capex lines will change on the margin in JWN’s favor by mid-year. At that point, we might actually look to go long this one. After all, it’s the only department store that really needs to exist, and it’s trading at less than 7x a doable EBITDA number.
In the end, we’d actually look to buy it on a sell-off on tomorrow’s numbers – something in the low-mid $40s sounds about right. Otherwise we might be interested in buying with a $5-handle later this year when the Macro environment is de-risked and JWN emerges from ‘investment mode.’
Trade (3 weeks or less): JWN is the only name amongst its peer group that has been radio silent throughout the holiday season that saw M and KSS pre-announce earnings growth rates of -20% (-30% ex. the Brooklyn asset sale) and -15%, respectively. Management lowered the 4Q bar by 9% post the 3Q print, and then the Street came down by another 7% over the past three months. Sales expectations still look too high given the general softness in the retail space (especially at the high end) over the holiday period and the fact that JWN is up against its toughest comp since 4Q12. E-commerce traffic trends have been soft across all of JWN’s concepts as it laps the launch year of the Rack website, while Full Price and Hautelook continued to weaken into quarter close. We’re about $100mm, or 2%, below the street.
These Traffic Trends Look Terrible
On the margin side, JWN likely took the biggest hit of any of the department store players in the quarter with gross margins down 160bps in 3Q, as it proactively managed its inventory position. Warm weather and weak demand will still be an issue in 1Q, and we expect inventory growth ahead of sales for the 16th time in the past 18 quarters. Canada and Trunk dilution is starting to roll off now that the sales base North of the border is forming a critical mass and the acquisition of Trunk Club is annualized. The company pulled a few SG&A levers last quarter by cutting its investment in its loyalty program (bullish for credit income). All in we’re modeling a 200bps hit to EBIT, broken out into 110bps of deleverage in the core, another 40bps from non-core investments, and the remainder allocated to the sale of the credit card receivables.
3Q15 SIGMA Chart
Trend (3 months or more): Not unlike the rest of the retail space, the street is looking for a snap back on the top line as we enter 1H16, chalking up most of the demand issues we saw in the back half of 2015 to just weather. We’re not buying it. And, after what we think will be another sales miss in the 4th quarter we expect the guide for 2016 to be conservative on the top line. Or, at least it should be given the price action on the stock over the past 3 months and the fact that short interest is at 5 year highs at 19% (up from just 6% in late November).
Here’s where we come out on each of the lines on the P&L in the first half of 2016…
JWN has the makings of a textbook long. Here’s why…
1) For starters, we have to ask the question does JWN need to exist? We think the answer is unequivocally yes. It has arguably the best e-comm operation in all of B&M retail, premium content, a concentrated footprint in the top malls/MSAs outside of the Northeast, and can hit 300 rack doors without skipping a beat. We’re not convinced that the ‘non-core’ (Canada/Trunk) growth drivers are ROIC accretive, but expectations have come down to a level where we think the point is moot.
2) JWN is coming off a peak investment year, and while there is still $3.1bn left on the $4.3bn 5 year CapEx plan, 2015 marks the tops of capital investment. Margins are washed out as the company invests in the Rack rollout (27 doors added this year), Canadian entry, new East Coast fulfillment center, credit card receivables sale, and absorbs the Trunk Club acquisition. That should in turn fuel top line growth in the HSD range once we enter the back half of 2016 (consumer environment permitting).
3) We don’t have to make wild profitability or sales assumptions for this model to work. By 2017, we assume that Full Line EBIT margins are 100bps off 2014 levels, Rack EBIT margins are 50bps off of 2014 levels, slight improvement in e-comm margins as the business (Rack and Full Line) climbs to ~$4bil, and a profitability donut in the non-core side of the business (Canada/Trunk). At that point Canada will be around a $400mm business, with the entire full line buildout complete, and Trunk (which was break even when JWN acquired it) will have benefited from 3 years of integration. Any improvement in each of the four segments will add additional upside.
4) On that math we get to earnings of $4.13 in 2017 on a sales base just north of $16bn. 6% ahead of the street today and likely higher as numbers come down after 2016 expectations are reset.
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Below, we provide rebuttals we have heard this week to our short case. If you missed the call and would like the slides, replay, or EQM model/data set, please ping us back and we can send them along.
Insider Buying Not Positive, 1 For 2 Match Program Perquisite: Every ATU long we spoke to pointed at recent insider share purchases as a bullish signal. It is true that insiders have purchased stunning ~400,000 shares since October, and that the buys attracted media headlines that helped push ATU shares higher. What many seem not to have noticed was that ATU’s proxy included a provision to incentivize insider purchases. The Matching Restricted Stock Grant Program matches insider purchases in October, December, and March with one share of restricted stock for every two shares bought by the senior executives. The program doesn’t appear to extend to all employees, and seems designed to create promotional excitement about insider buying.
Sum Of Parts Wrong Framework: Prior to presenting, we reviewed sell side reports on Enerpac suggesting that such a quality franchise can sell for a mid-teens EBITDA multiple. In those reports, ATU is cheap because Enerpac is worth a good chunk of ATU’s full enterprise value. There are many problems with this rationale. First, Enerpac can’t be sold without violating debt covenants, by our read. Second, a sale of Enerpac would generate significant tax liabilities. Third, as we understand it, Enerpac is not neatly separable from its intercompany relationships inside ATU (e.g. Hydratight). A sum-of-the-parts methodology only has substance insofar as it reflects a potential economic reality. Most critically, we don’t think a buyer would pay such a big multiple for a company with contracting margins and core sales falling at a 9% rate. Many key Enerpac end-markets are collapsing (e.g. mining, shipbuilding, oil & gas). We are pretty sure a buyer would have access to newspapers. In a sense, our thesis is that the valuation of Enerpac and other ATU businesses has declined and will continue to do so. Most peaking cyclicals seem like premium, highly regarded franchises at peak.
ATU Doesn’t Deserve A High Multiple Of Trough Results: Multiples of earnings, EBITDA, and even sales are a truly horrible valuation approach for cyclicals. Even though we keep writing things like “we are pretty sure that is covered in the CFA materials”, the sell side and investors continue to apply P/Es and EBITDA multiples on “mid-cycle” estimates (or peak or trough). Companies typically spend little time at ‘mid-cycle’ results, and cyclical declines can last for decades in resources capital equipment. See how well P/Es worked for CAT and DE from 1. We typically develop alternative measures in understanding in long cycles, and prefer to use a DCF to make the cycle assumptions explicit. As a current non-ATU example, look at DE’s P/E and decide if it is relevant in the event of a large decline in real farmer equity. ATU and other resource-related capital equipment companies are likely value traps that will look cheap while continually underperforming.
Commodity Capex Bubble Popped, Like Expecting A Dot-Com Recovery In 2001: Many holders think that oil & gas and other commodity markets have been suppressed in the last couple of years, and will recover. We do not think that is accurate. The bubble in commodity-related capital spending peaked out a couple of years ago, and has been deflating toward more normal levels. We don’t think this is the trough. Rather, we believe commodity related capital spending is returning to normal levels, and is not ‘suppressed’ below them.
ATU Is Exposed To Commodity-Related Capital Equipment: A couple of people insisted that infrastructure and general industrial were the ATU exposures that really mattered. We are not sure this point is up for debate, since ATU provides its market exposures. ATU’s relative share price performance tracks CRB and Crude extremely well since the company pivoted to resources. The industrial segment core revenue growth (below) similarly looks like many other resource-related capital equipment companies. We don’t see a reason to doubt what the company itself has provided.
Takeaway: What to watch on the election 2016 campaign trail.
Editor's Note: Below is a brief excerpt from Potomac Research Group Chief Political Strategist JT Taylor's Morning Bullets sent to institutional clients each morning.
Our top story is that Donald Trump is going to build a wall around the Vatican and make the Pope pay for it. It will be the biggest wall around the world's smallest country, but it will be beautiful. Actually, what he really said in reaction to Pope Francis challenging his Christianity was: "If and when the Vatican is attacked by ISIS, which as everyone knows is ISIS's ultimate trophy, I can promise you that the Pope would have only wished and prayed that Donald Trump would have been president because this would not have happened."
Just when we thought this election couldn't get any more surreal. With SC Republicans casting their votes tomorrow, we don't think that this spat with the Pope will have much of an impact on the outcome -- but a handful of the many polls just released this morning show a tightening race in the Palmetto State.
South Carolina increasingly looks like a fight to the death between Marco Rubio and Jeb Bush. Bush faces a political death spiral if he finishes behind Rubio, which would demolish the rationale for his candidacy. Rubio faces a financial death spiral if he finishes behind Bush; his campaign needs to tap into sidelined establishment donors and current Bush backers in order to stay afloat.
Unless Bush pulls off a big surprise this weekend, his supporters are likely to bolt for Rubio regardless of whether he concedes or formally endorses his fellow Floridian. Meanwhile, John Kasich will go underground until the Michigan primary on March 8th.
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