Takeaway: We added DE to Investing Ideas on the short side on 4/19.
THE HEDGEYE EDGE
We see DE as a highly cyclical, capital equipment supplier to a mature, zero growth industry. Deere’s key, high margin franchise is large, North American ag equipment. Prior to 2014 or so, that market experienced a decade long surge in equipment sales, driven by soaring crop prices, increasing land values, and comparatively easy credit. Since peak, these factors have begun to roll over. We expect the hangover – elevated new & used equipment inventories, excess manufacturing capacity, tightening farm credit, and declines in farmer equity – to be a prolonged affair that gradually takes equipment sales below ‘normalized’ demand.
We expect total North American agricultural equipment sales to drop roughly 2/3s peak to trough, and FY15 results are only about half way there. Newer downside drivers appear likely to come from tightening credit, decreasing land values, declining farm equity, and lower crop prices. As those factors influence equipment sales, we expect FY17 estimates to move to <$3.00 vs. current consensus of about $4.10. As investors price in the reflexive unwind in this commodity-related capital equipment industry, we expect to see another 30%-50% relative downside in shares of DE.
INTERMEDIATE TERM (TREND)
While most of FY16 is baked into the share price, there are a couple of noteworthy items concerning DE and its customers. New and used inventories, dealer sentiment and credit metrics are deteriorating. Further credit tightening can pressure residual equipment values and Deere’s Finance subsidiary which has seen an uptick in past due loans. These indicators show that the Ag downturn is still underway and not approaching ‘trough’ levels as consensus believes in 2016.
LONG TERM (TAIL)
We agree that FY16 is about right, give or take ~10%. But the differentiator versus consensus is for FY17. We think that FY17 estimates are far too high and expect an FY17 reset as a downside catalyst. We do not think that a 60%+ NA Ag equipment spending decline peak to trough is what the market is expecting. Bullish analysts still think that FY16 is roughly trough, and is well below ‘normalized’ demand. As a result, some see DE as a relatively defensive machinery name. We expect that optimism to fade, just as it has for other commodity production capital equipment shares (e.g, CAT, JOY).
ONE-YEAR TRAILING CHART
Takeaway: U.S. jobs growth peaked in Febraury 2015. It's been all downhill ever since.
Despite financial media headlines trumpeting "Everything You Need To Know" about today's jobs report, the Old Wall media missed the most obvious story of all. Digging a tiny bit deeper reveals the real story. Job growth peaked in Febraury 2015. It's been all downhill ever since.
Sure, we all know job growth slowed to 160,000, well below the 200,000 number Wall Street economists were predicting.
Blah, blah, blah...
Digging just a tiny bit deeper reveals the actual story.
Job growth peaked in Febraury 2015. It's been all downhill ever since.
Here's the detailed breakdown:
And finally, a message from our outspoken CEO Keith McCullough. What you should have owned heading into today's #LateCycle Jobs Report.
Takeaway: Weak Dept Stores, weakest LB comp trend in a generation. The economy is fine tho… Gear up for a volatile retail EPS season.
KSS, JCP, M - JCP Memo Signaling Weak 1Q
Department store earnings start next week, and the NY Post stirred the pot in preview. This article discusses an internal memo from JCP management to store managers that declared significant cost cutting initiatives into quarter close. These cuts manifested in chopped employee hours and slashed T&E expenses.
The read-throughs here are very bearish for the rest of JCP's peer group. Coming off a low base JPC still has a lot of room to run as it regains parts of the $5.4bn it coughed up during the RonJon tenure. To date - the company has taken back only $800mm, with KSS being the biggest beneficiary. With JCP nickel and diming to manage expenses into quarter close, we would expect the hurt to be more pronounced on its competitive set as the comp trend in the industry continues to play out.
This is stage 1 of our 3 part KSS call continuing to play out. 'Stage 1' is characterized by weak sales simply as a result of the fact that KSS sells less and less of what consumers increasingly want to buy. The model is stretched with very few leverage points (not to mention the only sales line that is growing is online where the gross margin is 1000bps below a B&M sale), and no real estate optionality. Not to mention the risk to 30% of EBIT from a credit portfolio that has hit its peak. By the time our call gets to 'Stage 3', the dividend is wiped out, and this 'free cash flow support' we keep hearing about will wash away, taking valuation support with it.
For more details on our 3-stage KSS call, CLICK HERE.
LB - L Brands Stumbling in 2016
LB, traditionally one of the pillars of stability in the US retail group, continues its stretch of doing pretty much nothing right. Just 4 months into the year, the company has missed 3 times, and Fiscal Q1 EPS was guided below the street for the first time in over 3 years. The 2-year comp (see below) is testing negative territory for the first time in a generation.
The bear case about the Victoria's Secret catalog changes while the company is at peak productivity, peak margins, and cycle-peak multiples on almost every metric with only 3.7% of the float held short is clearly winning. But we're still intrigued here and continue to vet the name. In fact, it just got more interesting from where we sit. Stay tuned for a Vetting Book on that one.
AEO - American Eagle names Peter Z. Horvath Chief Global Commercial and Administrative Officer -- Horvath's previous roles include Exec VP COO at Victoria's Secret and President of Footwear at DSW
HBI - Australia Foreign Investment Review Board officially approves Hanesbrands' acquisition of Pacific Brands
WMT - Walmart reviving door-greeters after removing program in 2012 -- tested program last summer and will roll out to all stores by mid-summer
JCP - JC Penney teams up with Michael Strahan for new athleisure line, released men's tailored line last year
AMZN - Amazon CEO Jeff Bezos said company will hire over 25,000 military veterans and spouses over next 5 years -- in 2012 Amazon made effort to hire 10,000 veterans
Claire's Stores CEO Beatrice Lafon resigns & quits board, will be replaced by board member Ron Marshall
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, and 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.
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Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.