ATU | Feedback & Short Case

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.



Common Rebuttals


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. 


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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.


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ATU Doesn’t Deserve A High Multiple Of Trough ResultsMultiples 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.


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Commodity Capex Bubble Popped, Like Expecting A Dot-Com Recovery In 2001Many 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. 


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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. 


ATU | Feedback & Short Case - ATU 5 2 19




  • ATU Chose… Poorly:  Management shifted portfolio toward resources and repurchased share near the cycle peak. We estimate that well over half of ATU’s sales are exposed to resource-related capital equipment markets (e.g. Oil & Gas, Shipbuilding, Rail, Mining, and Ag).
  • Not-So-Light-Assembly, MRO Tools:   When looking at operating metrics such as Revenue per Employee and Revenuer per Square Foot, ATU’s metrics suggest it is more of a manufacturer than a light assembly and sourcing company as prominently noted by consensus and management. ATU is likely to get hit on the downside due to their leverage to fixed costs, in our view. We also expect MRO tools to behave like other categories of capital equipment, as investment should be tied to fleet/equipment growth.
  • Industrial Segment Won’t See It Coming: Management’s lack of visibility should be a concern for longs. Destocking and slower resource activity may impact this profit driver.
  • Energy A Mixed Bag:  Interestingly, Energy margins have declined during the boom suggesting their market position may be weakening. In the second half of 2016, comps will get tougher.
  • Value Trap:  We expect shares of ATU to look ‘cheap’ on multiples as it underperforms.
  • Catalysts:
    • Estimates to ratchet lower amid a weak demand environment.
    • New CEO to lower the bar and drop, what the street calls, a “reachable” FY2018 target.
    • Book-to-Bill to drop
    • More business impairments like


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JT Taylor: Donald Trump vs. Pope Francis... The South Carolina Primary

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. 

TRUMP'S Holy War

JT Taylor: Donald Trump vs. Pope Francis... The South Carolina Primary - trump 66


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.


JT Taylor: Donald Trump vs. Pope Francis... The South Carolina Primary - rubio pic


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.

Cartoon of the Day: Juggling Bull

Cartoon of the Day: Juggling Bull - juggling bull 02.19.2016


"We need to suck every last permabull into believing that the "bottom is in", then kaboom," Hedgeye CEO Keith McCullough wrote earlier this week.

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FHQ (Friday Housing Quant)

Takeaway: YTD returns for Housing stocks are awful, but falling rates, a flurry of insider buying, and campaign promises are helping on the margin.

Our FHQ (Friday Housing Quant) tables present the state of the publicly traded Housing complex in a simple, quantitative format that takes ~60 seconds to consume. 



  • Housing Macro |  “If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?”  Recall, that perfectly subjective question from the BLS - at a ~32% weighting in the Index -  anchors the CPI report and the Fed’s view of Inflation’s reality.  Shelter inflation made a higher high in the January data released this morning, accelerating to +3.2% YoY and again buttressed muted pricing growth across the balance of services and further negative growth in core goods pricing.  Rising rent costs flowing through to both Headline and Core CPI growth are supportive of the Fed’s inflation target and companies directly levered to rent inflation but the gains largely represent excess growth in a key consumer cost center a drag on other discretionary and housing related consumption. 

  • Performance Roundup: Housing stocks have posted YTD losses roughly double that of the broader market. While the S&P 500 is down 6.3% YTD, the average Housing stock has lost 11.6%: Title Insurance (-5.5%), REITs (-7.2%), Building Products (-7.7%), Home Improvement (-9.5%), RE Services (-13.3%), Homebuilders (-16.8%) and Mortgage Insurance (-20.9%). The only categories to roughly keep pace with the market are Title (+0.7% relative) and REITs (-1.0% relative). Among homebuilders, DR Horton is down 22% YTD, Lennar is down 18%, Toll Brothers is down 24.7%. NVR, the most defensive of the builders, is down 3.9%. Beazer, the worst of the bunch, has shed 40.3% YTD. 
  • Insider Buying: Insider buying has been heavy in the last few weeks. As we show in the tables at the end of this note, insiders stepped up to buy shares at BZH, KBH, TMHC, and PHM. Interestingly, while at PHM and KBH there was just a single buyer, at TMHC there were 5 different buyers and at BZH there were 9 different buyers.
  • Short Interest: Meanwhile, alongside the most insider buying, the largest increase in short interest  in the last two weeks was at KBH (+958 bps), HOV (+415 bps) and CAA (+355 bps). The three companies seeing the largest declines were LEN, NVR and MDC. 


Politician Promises / Housing Policy Update: 

At least one of the candidates has weighed in with their plan for US Housing reform. Secretary Clinton recently unveiled a plan to help jumpstart housing in economically depressed areas by, among other things, offering up to $10,000 in downpayment matching for select first time homebuyers. While the plan would largely rely on Congress for implementation, here are the provisions as described.


- Match up to $10,000 in down payments for home-buyers earning less than their neighborhood's median income.

- Increase funding and loosen lending requirements for borrowers who go through housing counseling programs.

- Push government agencies to use new ways to assess borrowers' creditworthiness.

- Give agencies 90 days to clarify their requirements for backing loans so that lenders will know how to offer more mortgages without violating new rules.

- Increase the number of affordable rental properties and offer more low-income housing tax credits in neighborhoods where there are shortages.

- Offer more funding to local governments that build affordable housing in neighborhoods with better schools and more jobs.



FHQ (Friday Housing Quant) - Subsector Performance


FHQ (Friday Housing Quant) - BQ 1


FHQ (Friday Housing Quant) - BQ 2


FHQ (Friday Housing Quant) - tmhc


FHQ (Friday Housing Quant) - bzh


FHQ (Friday Housing Quant) - phm


FHQ (Friday Housing Quant) - kbh


FHQ (Friday Housing Quant) - BQ 3


FHQ (Friday Housing Quant) - BQ 4




Joshua Steiner, CFA


Christian B. Drake

Stock Report: Darden Restaurants (DRI)

Takeaway: We added DRI to Investing Ideas on the short side on 2/16.

Stock Report: Darden Restaurants (DRI) - HE DRI table 2 19 16



Where do we go from here?


Having pulled all the levers to create shareholder value, it’s now down to the facts about how Darden's core business is performing. There are cracks in the Olive Garden story and the brand is not as healthy as the consensus believes.


Major capital investments are needed:


Olive Garden has been in need of a major remodel since FY2007. While the sales trends at Olive Garden have improved slightly, to sustain long-term growth the concept is in need of a major overhaul which will be expensive. As sales trends rollover at the brand, the need for significant capital investment will become more evident.


The real numbers suggest multiple compression:


Under the new business model the company is posting peak margins. In addition to significant capital investment, the company will need to invest in incremental food and labor costs to drive positive traffic across the enterprise.




Management doesn't seem to be thinking about Olive Garden the right way:


During the 2Q16 call DRI management was asked about unit growth plans:

  • CEO Gene Lee stated, “I think we’re going to get back on a path where we’re opening somewhere between 8 to 12 Olive Gardens a year, so that will be a big boost to our numbers. Olive Garden is still an incredible investment from a new restaurant perspective. There will be some cannibalization, but we think that Dave and the team have the strategy to identify trade areas that could support Olive Garden, but without so much cannibalization that we can’t make the returns work.”
  • He went on, “Obviously, we’re going to continue to push Yard House. And we think LongHorn can get back up to low double digits also. And so with those types of new restaurant development, we can firmly be in that 2% to 3% [unit growth] range.”

Management’s thinking about unit growth is clearly evolving as the year goes on, and yet, Olive Garden’s top line performance continues to struggle. Plus, they have gone from vocalizing that they will open 1 to 2 Olive Gardens a year, to 8 to 10, which implies 1.2% unit growth.


Additionally, they are not spending aggressively on fixing the business:


Olive Garden’s last remodel was completed at the end of fiscal year 2001, when Joe Lee held the CEO position and Clarence Otis was the CFO. Management defended the remodels during 2002, although they struggled to increased their alcohol sales, which were supposed to be a benefit of the remodels.


In fiscal 2011, management started early remodeling tests on Olive Garden. Olive Garden has about 400 older RevItalia restaurant models that are in dire need of remodeling. In 2011, they remodeled 35 to test the effectiveness of the prototype. Clarence Otis successfully kicked the remodel can down the road until he met his demise in 2014:

  • 2011 Annual Report: “Olive Garden will begin remodeling more than 400 early restaurants to be consistent with the Tuscan Farmhouse design of the restaurants opened in the past six years.”
  • 2012 Analyst Meeting 2/23/12: “Olive Garden now testing a remodel program for 430 pre-Tuscan Farmhouse restaurants that were built before March 2000.”
  • 3Q13 Earnings call transcript: “Olive Garden is preparing to implement their remodel program in the second half of this fiscal year.”

To date, Olive Garden has done 32 remodels, and is far behind schedule, on a massive remodel project. Clearly, no one wants to remodel the Olive Garden concept because it will be disastrous for earnings.




The Olive Garden is still not fixed and is in desperate need of a large capital investment to turn around their negative trends. Until management realizes this the business will continue to decline and the stock will go with it. Determining what management will do in the TAIL duration is not possible, and we don’t like to participate in that guessing game. What we know now is that Olive Garden is not fixed and management does not currently have a plan to rectify the situation.


Additionally, Darden is a multi-concept restaurant company and in our past experience it is very difficult for management teams to allocate capital effectively amongst its brands. On one hand you have high growth concepts such as Yard House, and on the other you have Olive Garden which makes up roughly 56% of sales and is in need of cash just to prevent declines. We look forward to following the story over the next couple of years to see what course of action management takes to recover the business.


Stock Report: Darden Restaurants (DRI) - HE DRI chart 2 19 16


Howe: How Demographic Trends Impact Your Portfolio


In this recent excerpt of The Macro Show, Hedgeye Managing Director and Demography analyst Neil Howe responds to a subscriber’s question about how the “glacial pace” of demographic trends and migration impacts investors’ portfolios. If you like this excerpt, you’ll love The Macro Show.

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