Hedgeye CEO Keith McCullough is arguably the most bearish guy on Wall Street.
Key Takeaway: We don’t want to be trite by offering a token golf clap to the U.S. economy bulls in response to the strong JAN PCE data and positive revision to Q4 GDP. It’s more appropriate to offer a standing ovation instead. But what happens after standing ovations? Hint: the audience sits back down... All told, our views on the likely progression of the domestic economic and financial market cycles remain unchanged (see section #3 below for more details).
Section I: January Personal Income & Spending Recap
Both income and spending accelerated to start 2016 as the combination of accelerating aggregate wage income and a small decline in the savings rate, off of multi-year highs, combined to drive sequential improvement in household spending. The January NFP data signaled as much (see: yesterday’s Early Look: Number 2 for details) so we got largely what we were expecting with the official release this morning.
An annotated visual tour of the underlying data is below but here are a few key points:
-Christian Drake, Senior U.S. Macro Analyst
Section II: Q4 GDP Revision Recap
The headline number beat on flimsy-at-best internals:
-Christian Drake, Senior U.S. Macro Analyst
Section III: Revising Our Outlook for U.S. Economic Growth
With the advent of this 1-2 punch of generally positive economic data, we are revising up our outlook for domestic economic growth:
Moving along, the conspiracy theorist in me doesn’t want to believe the strength in this morning’s JAN Real PCE data. Having consumed enough @Zerohedge tweets about seasonal-adjustment shenanigans over the past two weeks, I came away somewhat surprised to learn of no holes in today’s print. This was a good number and represents a healthier U.S. consumer than we anticipated when we published, “50 Charts On Why Consensus Macro Is Dead Wrong On the U.S. Consumer” back on January 19th.
In fact, further analysis would seem to suggest that U.S. economy bears such as ourselves were perhaps reading too much into the SA vs. NSA debate that’s emerged in recent weeks with the advent of the Retail Sales, Durable Goods and Capital Goods releases for the month of January. Specifically, the Z-Scores for the basis point spread between the SA and NSA YoY growth rates for each reading were 1.6, 0.7 and 1.0, respectively; each is on the high side of historical readings, but not high enough to suggest a not-yet-reported material leg down in the underlying health of the U.S. economy.
So what does this all mean for markets? We believe the three most important takeaways are as follows:
All told, we were wrong on the pace of economic degradation thus far in 2016 and hope you appreciate our objectivity and intellectual honesty here. We aren’t perma-bears insomuch as we aren’t perma-bulls. We have no horse in this race other than preserving our analytical reputations.
We simply want to be continue being right on forecasting the data and financial market returns from a trending perspective and our intermediate-term TREND calls on both remain unchanged.
-Darius Dale, Senior Global Macro Analyst
Hedgeye Retail analyst Brian McGough highlights three key points from Foot Locker's latest earnings report. If you like this excerpt, you’ll love our research.
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Of the major North American miners, Goldcorp finished off Q4 Earnings season last night with an awful print which included a net loss of -$4.3Bn when you include impairment charges of -$3.9Bn (-$128MM without charge).
In addition to the impairment charges, Goldcorp wrote-down the carrying value of heap leach inventory and stockpiles at two mines to the total of $104MM. The impairment and write-down charges assumed a long-term gold price of $1,100/Oz. While by no means apples-to-apples, the carrying value of Newmont’s stockpile and ore on leach pads is multiples of Goldcorp, and both companies previously assumed $1,300/oz.
These charges are a reality of a cyclical downturn, one that Newmont may be trying to push out as long as possible (or avoid). ABX and GG have taken impairment charges and downwardly revised for lower gold price expectations and Newmont has not. Rather, they’ve kept aggressive gold ($1,300/oz.) and copper ($3.00/lb.) price assumptions for capitalizing their much larger inventories and stockpiles.
We believe Newmont’s higher cost profile and aggressive capitalizations will matter in a lower gold price environment. However, we’ll be the first to say that these names are trading vehicles with leverage to gold prices, and being long of gold with leverage which has worked YTD.
With the release our monthly sector sentiment deck on Tuesday morning, we’ll outline some of the behavioral factors behind the move YTD as well as to outline what is becoming more of a consensus trade in gold ahead of policy catalysts in the coming weeks.
Behavioral factors along with Newmont’s failure to address aggressive accounting practices pushed us to add NEM to our Best Ideas on the short-side last week (link to the 02/18 note).
Below we use 4 charts to highlight what we view as two of Newmont’s biggest long-term headwinds:
In this brief excerpt from RTA Live, Hedgeye CEO Keith McCullough responds to a subscriber’s question about how we analyze financial markets (using price, volume, volatility) and how best to interpret what market volume is telling you. If you like this excerpt you’ll love Real-Time Alerts. Click here to learn more.
Editor's Note: In light of the recent blow to RH shareholders, please see the following research report written by Hedgeye Retail Sector Head Brian McGough. According to McGough, "My timeframe has always been on the company's 2018 numbers. The fundamental thesis still holds and should start to play out before then. But that's no excuse for getting caught in this collapse."
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As the mega bulls on Restoration Hardware, this preannouncement is a clear kick in the gut. But there are a few things at work...a) more than half of the shortfall was because RH couldn’t fill orders in its new Modern product line. We’d rather that than have no orders and too much product. b) Energy markets still a drag. c) the smallest part of rev miss (18%) is a miss in Jan as business slowed due to market volatility. Biz came back in Feb, we think, that qtr was not disclosed. d) incremental margin on lost sales is too high (41%) for this business model.
We think RH knew it had to preannounce, so it put the highest octane it could find in the preannounce-o-meter. All in, this stock is trading at 14x what we think is a trough earnings level. An all-out recession gets us $2.50 x 12, or $30. An acceleration in 2H with all its growth drivers (that no one cares about today) gets back above $100 in a year. We could talk about the 2-3 year earnings/multiple upside – but admittedly that does not matter now. How we see it, there’s $60 up and $10 down. We can search all year for better odds, and still never find it in US retail.
This flat-out stinks. We knew an 8k was coming from RH, but certainly wasn’t expecting a 35% guide down for the quarter, with no forward guidance whatsoever. Furthermore the company’s press release is riddled with ambiguity and lacks important context that we’re certain will hurt the stock more than it deserves. And to be clear, it definitely deserves to be down from a traders duration.
Our implied earnings for 2016 is $3.10, suggesting that the stock is trading at about 14x earnings. We can argue til we’re blue in the face how ridiculously low that multiple is for a company that grew 13% in a transition year (’15), should grow another 15% in a pseudo-recession year, and then 30%+ long term (starting in ’17). But in the end, we’re going to need to see this business stabilize and reaccelerate for the stock to work. That should be within two quarters.
As a frame of reference, we outlined two recession cases in our January Black Book (see link below), which implied $2.63 in EPS in a ‘normal recession’ (whatever that is), and $2.30 in EPS if we revisit the downside we saw in the Great Recession. Our $3.10 for this year is likely to come out ahead of consensus, and we’re relatively confident in our number.
But from where we sit, the magnitude of the revenue shortfall in no way is indicative of solid demand, and the earnings shortfall is even further overstated. By our math, we’re looking at $66mm. Consider the following.
Top Line: Reported a 9% comp versus prior expectations of 22% -- that’s about $66mm. There are several reasons for this.
Can someone explain to us how revenue missed expectations by $66mm, but EBIT missed by $27mm. Yes, that’s an incremental margin of 41%. That is simply ridiculous from our vantage point. Keep in mind that a given retail operation like Nike, Ralph Lauren, Tiffany, Ulta…you name it…keeps virtually all product in a storeroom or on the floor. The consumer picks the merchandise, pays, and they walk out the door satisfied. Given the inventory carrying costs associated with this model, and almost all retail models, the incremental margin on a dollar won or lost can often be as high as $0.50-$0.60.
But in a business model like RH, only 5% is ‘cash and carry’ (i.e. minimal storeroom usage) with the remaining 95% on order for delivery over the coming 1-2 months. That, by definition, means that the incremental margin on lost revenue will be dramatically closer to the company’s EBIT margin rate – usually 10-20%. So how or why did RH put up a 40% incremental margin?
As noted, RH’s incremental margin of 40% is simply too high. We’re completely reading into this, and would never look for anyone to confirm or deny it, but we think this high rate of flow through is on purpose.
Think of it like this…RH has never missed a quarter – at least not in this iteration of being public. And now, largely because of execution gaffes around keeping up with demand for a new product line (Modern), it has to guide down. This is a competitive management team, and one that definitely cares about its stock. We like that, but sometimes it comes at a cost.
The entire team has been in business planning sessions over the past month, and when a preannouncement became necessary, we think someone probably said something like “If we’re going to miss for the first time ever, let’s miss big, and make 100% sure it does not happen again.”
As such, we think RH likely made investments in the quarter that would have otherwise taken place in 2016 – hence taking the incremental margin on the revenue loss meaningfully higher.
We also think that the lack of 2016 guidance was purposeful. First off, the company gave a mouthful and plenty to digest with this announcement. Second, the consensus numbers for 2016 are likely to come down 20% or better given the absence of any other information. THEN, when RH issues guidance on March 23, it will have a very low hurdle – and it probably won’t guide much above that.
Then we’ll have a low earnings bar, likely upside to earnings, anniversarying weakness in Energy/FX markets, a meaningfull step-up in contribution from six opened design galleries as they enter the key part of the maturation curve, and an upgraded vendor base for Modern and Teen. THEN and only then will people care about the outsized square footage growth, new product flow, and astoundingly favorable rent structures on new properties.
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