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McCullough: Why Our GDP Forecasts Are So Accurate

 

In this special excerpt from The Macro Show this morning, Hedgeye CEO Keith McCullough takes subscribers “behind the curtain” on our quantitative forecasting model and how we interpret and debate evolving economic data.


5 CHARTS: Fed Forecasters Flat-Out Wrong

5 CHARTS: Fed Forecasters Flat-Out Wrong - fed forecast crystal ball

 

What do you call an economic forecasting outfit which continually calculates future economic growth and misses time and time again?

 

"Wrong"?

 

"challenged"?

 

...Certainly not "credible."

 

Whichever derivative of "inaccurate" you choose to use, they all apply to the Federal Reserve's economic modeling. Incidentally, it's funny that Fed prognosticators came out so strongly in favor of future rate hikes yesterday when they seemingly have no clue whatsoever about the direction of the U.S. economy.

 

5 CHARTS: Fed Forecasters Flat-Out Wrong - Fed grasping cartoon 01.14.2015

 

Here are a few of the more shocking recent Fed governor comments that we simply couldn't ignore:

 

  1. “A rate hike could be appropriate, if the data is as expected.” –John Williams (San Francisco Fed Head, yesterday)
  2. The economy is offering mixed signals, but favors unemployment data.” –Dennis Lockhart (Atlanta Fed, yesterday) 

 

As Hedgeye CEO Keith McCullough pointed out in today's Early Look:

 

"Recently reported GDP of 0.5% isn’t in the area code of 'as expected.' I don’t think Williams has a lot of credibility as a Wall St. forecaster."

 

Meanwhile, Lockhart's Atlanta Fed updates its much-watched GDPNow estimate throughout the week. The measure seeks to project what recent data points mean for economic growth.

 

However, in the chart below, we show just how wrong that model has been over its lifespan (a.k.a. it has an intra-quarter standard error of 200-250 basis points!). Note: Our own GDP predictive tracking algorhythm has actually been, on average, within 20-30 basis points of getting the US GDP number right for the last 5 quarters (the historical standard error in our model is 35 basis points).

 

5 CHARTS: Fed Forecasters Flat-Out Wrong - atlanta fed post

 

That's why we're deeply skeptical of the most recent GDPNow reading of 1.8% for Q2 2016. (Note: Applying the aforementioned standard error means Q2 GDP could be between -0.7% and 4.3%!)

 

Outside the Atlanta Fed's challenged algorhythm, Hedgeye Senior Macro analyst Darius Dale has peeled back the onion on the Fed's official GDP projections. Unsurprisingly, these unelected bureaucrats are both incorrect and serial over-optimists:

 

5 CHARTS: Fed Forecasters Flat-Out Wrong - fed overoptimism

 

Similarly, back in October, we highlighted the absurdity of the Fed's forecasting in our 73-page Q4 Macro themes deck. Back then, the Fed was predicting the "longest economic expansion ever."

 

5 CHARTS: Fed Forecasters Flat-Out Wrong - CoD Fed Optimism

 

Now, You might be wondering...

 

Can't the Fed simply turn dovish like last week's "no April rate hike" soothsaying?

 

No. Investors betting on the direction of rates had pushed the next hike into December of 2017.

 

5 CHARTS: Fed Forecasters Flat-Out Wrong - Chart of the Day 4 20

 

So what happens when the Fed admits they are wrong about growth (and Hedgeye's economic predictions prove correct)?

 

Frankly, it will be too late for the Fed to save the day.

 

Here's the selloff that occured during the last two downturns.

 

5 CHARTS: Fed Forecasters Flat-Out Wrong - fed post drawdown

 

As we continually reiterate, the biggest risk to macro markets is believing in the Fed's serially overoptimistic economic projections.


Net Neutrality Black Book and Call

Thursday, May 5, 2016 at 11 am ET

Please join us for a Black Book presentation on the FCC's net neutrality rules. We expect imminently a major federal court decision on the legality of the FCC's Open Internet Order, a decision that will likely alter the legal entitlements of leading Internet content providers (NFLX, FB, AMZN, GOOGL, DISH) and the network management rights of wired and wireless Internet service providers (CMCSA, CHTR, TWC, CVC, T, VZ, TMUS, S).  The rules of the game for the Internet ecosystem could change in a significant way.

 

If the court issues its decision before this coming Thursday, we will hold a flash call discussing the outcome and implications of the decision.

 

 Our Opinion:  The court decision has been pending for several months.  Although absolute predictions about judicial outcomes are not possible, we expect, based on available inputs, a mixed outcome with the wired Internet service providers (cable and telco broadband)(CMCSA, CHTR, TWC, CVC, VZ, T, CTL) subject to continued regulation as common carriers, a disappointing result for them.  We expect wireless carriers (T, VZ, TMUS, S, USM), however, to gain greater freedom to manage and monetize their networks with fewer regulatory burdens, a plus for wireless carriers and potentially the network infrastructure vendors that support their growth and expansion.

 

The Black Book will be available before the call and can be accessed here:
CLICK HERE

 

The Black Book will include a focus on:

  •            The legal case to strike down the net neutrality rules
  •            Disruption of the FCC's overriding policy objective to empower edge providers over ISP "gatekeepers"
  •            How the upcoming court decision could change the rules, creating new risks for edge providers
  •            How the court decision could bolster new revenue models for wireless carriers
  •            Follow-through on potential Supreme Court review and legislative proposals in response to the court's decision


For more information, please contact

  •          Toll Free:
  •           Toll:
  •          UK: 0
  •          Confirmation Number: 13636750
  •          Materials: CLICK HERE

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KATE | Find Me Another 50%+ Forward CAGR

Takeaway: Seriously, not many 50%+ names out there. The profitability is still what we thought, but we’re finally seeing consistency.

INVESTMENT CONCLUSION

This quarter was ‘about in-line’, meaning that revenue, EBITDA, EBIT, EPS and Guidance were all at or slightly better than expected.  ‘In line’ might not seem like a big deal, but make no mistake… For KATE, ‘in-line’ is a huge deal. First off, let’s keep one thing in mind. KATE just put up a 19% comp, and 50% growth in e-comm, by our math. That’s the biggest comp in all of retail. You can say the same about KATE in 3 of the past 4 quarters. #respect. When it beat comp expectations in the past, however, it would usually manage to miss revenue (like it did all last year). Not this quarter. This time it beat. Only by 2%. But it still beat.

 

More importantly, this is a company that has lost money every year since 2007. Despite having strong sales momentum over the past three years, it had no EPS, and only a convoluted non-GAAP Adjusted EBITDA number that was impossible to model. When the ‘handbag space’ melted down – KATE’s brand was fine, but its stock was annihilated because it had zero earnings/cash flow and valuation support. Well, that ends now. True, we only saw $0.05 in EPS this quarter (up from $0.03 last year), but that will accelerate meaningfully both sequentially and y/y. When all is said and done, we’re at $0.85 this year and a 3-year CAGR of 54% through 2018. Even if we’re wrong and KATE ‘only’ earns the consensus, we’re still looking at a 44% CAGR. We can count on one hand the number of companies that will put up that kind growth in US Retail.

 

Is 29x current year EPS rich? No, it’s not. Within 12-18 months, people are likely to be eyeing $2+ in EPS power – and that’s with the company investing at a continued high rate in the brand to facilitate such profitability. Importantly, our margin forecast in 2018 is 19% -- well below the 32% peak achieved by competition such as KORS and COH. Those companies underinvested and over-earned. That won’t be the case with KATE. In the end, we think that $2.00 in EPS power at a scant 0.5x PEG multiple (or 25 p/e) suggests a $50 stock by the end of 2017. Basically, that’s a double from where we are today in a very underowned stock. 

 

KATE | Find Me Another 50%+ Forward CAGR - 5 4 2016 KATE chart1

 

DETAILS OF THE QUARTER

When Boring Is Good – Over the past 3 years and change (13 quarters) KATE has been consistently inconsistent in its quarterly numbers. Here’s a quick recap: comps beat consensus expectations 100% of the time, this quarter was no different with comps coming in at 19% vs. the Street at 12.5%. Despite the consistent comp outperformance sales have missed consensus expectations in 8 of 13 quarters, including every quarter in 2014. This quarter KATE actually beat, as the noise which clouded most of the models due to discontinued operations (Jack Saturday) and the conversion of Intl businesses to JV/distributorship agreements is now completely in the rear-view. The flow through to EPS has historically been just as noisy, with the company missing earnings expectations in 7 out of 13 quarters, but this quarter the print was right in line. While we can poke holes in the flow through to EBITDA margins from a 19% comp, the fact is that KATE is now a model-able company actually earning money on a GAAP basis, which we think quiets a lot of the concerns which plagued the name for the better part of 2015.

 

“Mid-Tier Distribution” – This is an evil word in retail nowadays, and may give bears a negative to latch onto from this print. And to be fair, management could have done a better job clarifying just how dep down the value curve the brand was going in order to open distribution. But, we give them credit for sticking to the distro game plan. Over the past few quarters it’s clear that the store growth would be calculated in North America. We’d much rather see the company open the tightly guarded wholesale distribution pipeline on a case by case basis to hit 2nd or 3rd tier markets rather than opening hard physical assets in markets that may not support the ROI KATE has become accustomed to. That distribution strategy makes even more sense now that KATE has cleaned up its promotional posture within wholesale accounts. Overall we view this as a positive.

 

Noise, Over and Done With – Now that we’ve passed this 1Q print the noise on the P&L is over and done with. The last remaining remnant of the 2015 restructuring was the SE Asia/China JV which cost the company $6mm in sales this quarter. From here on out we are looking at an apples-to-apples comparison within the operating segments. We still have issues with adjusted EBITDA numbers and lack of clarity on the size of segments by channel (retail, wholesale, and licensing), but KATE is lightyears ahead of where it was at this time last year. That’s bullish for anyone incrementally new to the name trying to wrap their hands around this business model.

 

Key points on line items:

  • Unit/Sq. Ft. Growth:  Total owned units were up 11% YY in the quarter, with the total store count up 24% inclusive of partnered unit growth. That’s primarily a function of metered growth in NA and a shift in the international store growth in newly minted JV/distribution JV territories. We think it’s important to point out the extremely big e-comm growth rate despite the slower store opening cadence in NA, which speaks to KATE’s ability to reach beyond its store footprint to attract new customers on the e-comm side.
  • Top Line: Comps 19% on C$ basis, though Fx was neutral. That translated to 15% reported growth (or 20%+ excluding the $10mm watch inventory sale in 1Q15 and $6mm in sales from China/SE Asia). The non-comparable Asia and watch anniversaries explain away the delta between comp growth and reported top-line. On the e-comm side, the channel added eleven percentage points to the reported comp. At just over 20% of sales that means the e-comm channel was up 40%-50%. We expect more of the same as the company laps two more quarters of negative Flash Sale growth.
  • Gross Margin: No flow through from a 19% comp as 80bps of merch margin improvement were offset by 100bps of headwind from Fx and a promotional outlet channel. If we had to pick a bone with this print it would be on the GM line and corresponding inventory level, but management set the bar from improved GM flow through for the balance of the year which translates to accelerated earnings growth. We’ll stomach near term choppiness for the longer term picture as licensing categories pick-up steam and Li&Fung benefits are recognized.

PCLN | Beta Test Results

Takeaway: Tracker caught the 1Q acceleration, but whiffed on 2Q bookings trajectory. Guidance may be conservative, but tracker needs work regardless.

 KEY POINTS

  1. TRACKER BETA TEST RESULTS: The good news is that the tracker caught the 1Q bookings acceleration to within 1% of actual bookings, exceeding management guidance by 200bps.  The bad news is that our bookings tracker predicted bookings too far ahead of management guidance, which is the more important metric.  As we noted yesterday, the Hedgeye PCLN bookings tracker predicted 2Q bookings growth in the mid-20% range.  Today, management issued 2Q bookings guidance of 11%-18%, so approximately 10% below our model.  More importantly, the tracker was directionally wrong as we expected acceleration in 2Q bookings guidance versus 1Q bookings.
  2. SO WHAT HAPPENED? Management clearly indicated that April bookings growth decelerated from 1Q, but also suggested that they’re assuming further deceleration through rest of the quarter.  We suspect this could be an attempt by the new CEO to rebase expectations following particularly strong 1Q results (e.g. room nights growth at 2-yr high), especially since 2Q guidance showed considerable deceleration across all metrics.  Our tracker also failed to pick up negative ADR expectations.  Finally, the timing of the European football (soccer) tournament in France may have pulled forward bookings from 2Q into 1Q as hotel occupancies run full and reservations are made well in advance.  Looking ahead, our tracker is not yet showing further deceleration throughout the quarter. If we’re right here and the guidance is overly conservative (sandbag?), actual 2Q bookings could ultimately exceed management guidance by the more than typical 2-3% and come in closer to our mid 20s% prediction.
  3. MOVING FORWARD: While we’re happy with the 1Q accuracy, we’re clearly disappointed that our tracker missed the more important 2Q bookings guidance.  While there are some mitigating factors, the tracker clearly needs work in projecting the forward quarter bookings.  Tracker adjustments for the calendar and event issues are easy.  We think we understand the issues with the tracker as it relates to the early deceleration, but the related modification to the tracker requires more work on our part.  However, we believe we’re on the right track theoretically, and that a modified tracker will do a better job going forward.  Sometime this quarter, we will introduce our modified tracker as part of a deeper dive into the drivers of the PCLN story.  Stay tuned.

 

Let us know if you have questions, or would like to discuss in more detail. 

 

Hesham Shaaban, CFA
Managing Director


@HedgeyeInternet

 

Todd Jordan
Managing Director


@HedgeyeSnakeye


The Daily Macro Market Data Dump: Wednesday

Takeaway: A closer look at global macro market developments.

Editor's Note: Below are complimentary charts highlighting global equity market developments, S&P 500 sector performance, volume on U.S. stock exchanges as well as rates and bond spreads. It's on the house. For more information on how Hedgeye can help you better understand the markets and economy (and stay ahead of consensus) check out our array of investing products

 

Click to enlarge

 

The Daily Macro Market Data Dump: Wednesday - world equity markets 5 4

 

The Daily Macro Market Data Dump: Wednesday - s p sector 5 4

 

The Daily Macro Market Data Dump: Wednesday - volume 5 4

 

The Daily Macro Market Data Dump: Wednesday - hedgeye rates   spreads


Early Look

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