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Ex-Energy Earnings Still Terrible

Takeaway: A total of 458/500 S&P 500 companies have reported aggregate sales and earnings growth down -2.4% and -8.7% respectively.

Ex-Energy Earnings Still Terrible - oil mlp

 

A total of 458/500 S&P 500 companies have reported aggregate sales and earnings growth down -2.4% and -8.7% respectively.

 

Here's the breakdown by sector:

 

  • So far, 6 of 10 sectors have reported negative sales and earnings growth;
  • Our favorite sector short, Financials (XLF), reported sales and earnings growth down -1.7% and -14.3%;
  • Energy (XLE) sales and earnings growth down -31.6% and -108.7% respectively;

 

Click image to enlarge

Ex-Energy Earnings Still Terrible - s p earnings 5 17


HBI | Black Book - Best Idea Short

Takeaway: Please join us Monday, May 23rd at 1PM ET for our Black Book on Best Idea Short HBI.

Please join us Monday, May 23rd at 1PM ET for a call reviewing our Black Book on Best Idea Short Hanesbrands (HBI). 

 

WATCH THE REPLAY BELOW

 

Call Details:

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Confirmation Number: 13636869

Materials: CLICK HERE

 

We added HBI to our Best Ideas list as a short on May 2nd as recent acquisitions gave us higher conviction in our short positioning.  This goes beyond the whole ‘peak margins, low cotton cost, in a weak category’ argument. But rather, a management team that was aggressive, but is now behaving in a borderline reckless manner. Management is aggressively selling stock while it uses shareholder capital to accelerate acquisition activity at increasingly high (and potentially deceptive) multiples at the tail-end of an economic cycle, as its own factories operate near peak utilization. These deals are supporting earnings, while the Street looks right through the special charges. That makes timing on this short difficult, but we’ll provide a roadmap in our Black Book. Ultimately, we see 40% downside from here.

 

 

Below is our note from 5/2 outlining our thesis.

 

05/02/16 09:19 AM EDT

HBI | This Doesn’t End Well

 

Takeaway: We’re adding HBI to our ‘Best Ideas’ Short list. When a company behaves this badly, no one wins.

 

We’re adding HBI to our Best Ideas Short list. We initially put this short on in late March (see note below), but the company’s actions since then have given us greater confidence in the call. Here’s our basic thinking (we’ll have a Black Book out on the name shortly with a deep dive).

  1. This is not a bad business…but it’s not a good one. On the plus side, it’s highly consolidated on the brand side – with Hanes and Fruit of the Loom accounting for 24% share. On the flip side, distribution is even more consolidated with Wal-Mart, Target, Kohl’s, Penny, and (yes) Amazon accounting for ~70%.  That might seem like a push, but we’d also argue that consumer trends are pushing towards the high end (Tommy John, Lululemon, UnderArmour, Nike). All in, the core is probably a 1% long term grower. Nothing to write home about. And unlike a CPG company, it is extremely volatile. A volatile 1%? Not where we want to be.
  2. Margins are at peak. HBI’s own manufacturing plants account for roughly 65%. While the company guards these numbers closely, our sense is that utilization is likely running close to 90%. That’s actually to management’s credit, as they’ve got this engine running like a 911 Turbo. But where’s it going to go from here?
    Most retail analysts don’t cover companies that actually own manufacturing assets. They all have offshore/outsourced models that lock in price, limit volatility, and make it such that the company has to worry only about design, sales and marketing. The point is that margins for these ‘other’ brands might move by 1-2 points in a year. But for a company like HBI that owns its own assets, we could see 4-5 point swings with no problem as demand shifts and factory utilization drops. 
    In the end, we ask the question…why should HBI have higher margins (15%) than VF Corp, PVH, Ralph Lauren, and even Nike? We should note that it’s about on par with Gildan, which interestingly is the only other major company that buys cotton directly in such quantities for use in company-owned plants.   
  3. The New ‘Jones’? No, we’re not talking about Hedgeye’s illustrious Daryl Jones, we’re talking about Jones Apparel Group – one of the worst companies in retail. Ever. And that says a lot. As its core rolled, Jones took capex down from 2-3% of sales to about 0.7%. That’s bad. It took shareholders’ capital and bought assets/brands – over 25 of them. Then it took special charges almost every quarter obfuscating the real earnings power of the company. It was a great trading stock until it ultimately went private at 30% of peak trading levels.  We’re not certain this is where HBI is headed, but the parallels are uncanny.
  4. Management is investing away from the core. Maybe this is an exceptional idea. Maybe they’re doing what VFC did a decade ago when grew away from its stodgy old slow growing denim business, and sold off its underwear assets. But VFC bought things like Vans, Timberland, Lucy and Eagle Creek. HBI is diversifying into…you guessed it – underwear (and moderate priced sports apparel). Just in other parts of the world. We have no reason to think this category will grow any more outside the US than inside its borders.
  5. These deals are getting more expensive. HBI bought DB Apparel for 7.5x in 2014, Knights Apparel for 8x in 2015, and now both Champion Europe and Pacific Brands cost 10x EBITDA. Basically, HBI is trading at a 20% lower multiple (tho still expensive) than it was, but it’s deal multiples are 20% higher. Why?
  6. Why didn’t HBI buy Pacific Brands a year ago at half the price? That’s kind of a rhetorical question. I have no idea what the answer is. But it’s a public company…it’s not like it ‘wasn’t for sale’, and it’s also not like ‘HBI wasn’t a buyer’.  Just strange to pay nearly $400mm more for the same asset. That could have otherwise paid down 18% of debt, or bought back 3% of the float.
  7. 2 and 20 is Back! Did we mention that HBI announced two acquisitions in 20 days? One in Europe, and the Other in Australia? I’m sorry, but even if you’re the biggest bull on this name, you’ve gotta be scratching your head over this. Yes, I know, the stock was up on both deals, because people know that the company now has a cookie jar to dip into for a year or two. But we’ll bet against two international deals/20 days any day of the week when we’re at the tail end of an economic cycle.

 

The Bottom Line

We think it’s absurd for a stock like HBI to trade at an EBITDA multiple in the teens. An EARNINGS multiple? Sure. But not EBITDA. We understand, however, that this is the type of name where there will need to be a major event to make people completely revalue the company – the way it did so on the upside as it repaired its balance sheet over the past two years. But until then, will we see the multiple push to 14x, 15x? We have a hard time with that one – unless we’re grossly underestimating a) how much juice it can squeeze out of the lemon in Australia, or b) the sustainability of its positioning in the US market. If we’re right, we’re looking at 7-8x EBITDA, and we’d argue that’s even generous. That’s a stock in the mid-teens, or 50% downside.


Daily Market Data Dump: Tuesday

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

 

CLICK TO ENLARGE

 

Daily Market Data Dump: Tuesday - equity markets 5 17

 

Daily Market Data Dump: Tuesday - sector performance 5 17

 

Daily Market Data Dump: Tuesday - volume 5 17

 

Daily Market Data Dump: Tuesday - rates and spreads 5 17


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The Drought is in Credit: Key Call-Outs (AGU, CF, MOS, POT)

Takeaway: Fed farmer credit data shows 1) Tightening credit indices; 2) A decline in repayment rates; And, 3) A deterioration in land values.

The big question that will be answered in the intermediate-term is the effect of credit contraction, repayment rates, and land values on farmer input consumption trends. As we’ve highlighted with our recent calls in the Ag. space, we believe a deterioration in these metrics will prove meaningful:

  • The Chicago Farm Loan Repayment Index contracted from 43 at the end of Q4 to 32 through Q1 (-44% Y/Y) while the Chicago Fed Farm Loan Demand Index increased to 156 from 134 through Q4 (+11% Y/Y) – The Chicago Fed Fund Loan Availability Index was flat Y/Y.
  • The Kansas City Fed Loan Demand Index (nominal USD) is +6.2% Y/Y through Q1 and the Kansas City Fed Farm Income Index (nominal USD) is -73% Y/Y.
  • The Federal Reserve Bank of Chicago 7th District measurement of farmland values shows that farmland values are down -4% Y/Y, the largest rate of deceleration since Q3 of 2009. Cash rental rates for the 7th district are down -10% Y/Y.
  • Without having received updated data on past due real estate loans secured by farmland, loans 30-89 days past due were up 33% Y/Y through Q4, and there is no evidence to suggest a reversal in this trend.  

 

The Drought is in Credit: Key Call-Outs (AGU, CF, MOS, POT) - Chicago Fed Credit Indices

 

The Drought is in Credit: Key Call-Outs (AGU, CF, MOS, POT) - Chicago Fed Farmland Valuespng

 

The Drought is in Credit: Key Call-Outs (AGU, CF, MOS, POT) - KC Fed Credit Metrics

 

The Drought is in Credit: Key Call-Outs (AGU, CF, MOS, POT) - 30 89 Days Past Due Real Estate Loans Secured By Farmland

 

 


WSM | Really Don't Like It

Takeaway: Good news is that WSM will grow earnings by 10%. The bad news is that we’re talking 10% growth from LY - FY19 – and that’s not a CAGR.

The good news is that we think that WSM will grow earnings by 10%, which seems decent enough in this tape at face value. The bad news is that we’re talking 10% growth from last year through fiscal 2019 – and that’s not a CAGR, it’s total EPS growth over four-years. And if you were to ask us the over/under, we’d say that there’s a much better chance of earnings starting with a $2 than a $4 in any year therein. That’s our way of saying we absolutely do not like this company, its structure, its management team or its prospects. We think we have some compelling analysis to show how growth is coming from more price-sensitive consumers, at a point where brand growth is weighted towards the wrong end of the portfolio.

 

Duration Matters. We really really don’t like this company or stock long term (what we’d call a TAIL duration – 3-years or less). We also don’t like it over the Intermediate term (TREND – 3-months or more). But…and it’s a big but…our model does not point to a meaningful miss this quarter. Could the company guide down? Yes. It’s possible. But we wouldn’t call this a TRADE (3 weeks or less) into tomorrow’s print. Based on what we know today, we’d get heavy on the short side after the event – potentially even if we miss this one and it trades down.  If you have the luxury of ignoring a print with 14% of the float short, then by all means, short away. Over a medium to long-term duration it should prove to be the right call.

WSM | Really Don't Like It - WSM financials chart1

 

HERE ARE SOME KEY FACTORS DRIVING OUR NEGATIVE VIEW

 

Management: We’ve gotta start with our strong view that this management team simply doesn’t have the chops, the vision, and perhaps even the authority to do what it takes to turn this company from Good to Great in what is going to be the most dynamic retail climate in a generation.

What’s even more troubling than the choppiness on the top line we’ve seen reported over the past 6 months is management’s inability to articulate the root causes of the slowdown across all banners or identify clear and definable investments that need to be made in order to reignite the top line.

 

The WSM plan going forward is a patchwork investment plan centered around infrastructure additions, SKU reduction, store portfolio rationalization/improvement, and employment cuts. That screams defense to us. It’d be a different story if the company were going to take the additional cash flow saved after streamlining the back-end and reinvested that back into the value equation to stop sales from sliding. That’s not the case. The punchline is that a company in any industry rarely can cut costs and manufacture growth at the same time. Making minor strategic changes after a negative event – and not knowing why – is a recipe for disaster in this business.

 

The New 80/20: For the better part of this economic cycle, the gravy train for WSM has been sustained market share gains in Pottery Barn on essentially flat square footage. Prior to 2015, PB (inclusive of Kids and Teen)  amounted for the lion’s share of growth. That manifested itself in high-single digit comps taking operating margins from the recession trough of 2% into the double digits. That growth appears to have hit a wall, as the company looks to realign the brand once again to attract of lower demographic. Never a multiple inducing event.

 

Incremental growth is now coming from two sources, West Elm and Intl/New Brands, which collectively amount to 20% of the revenue base, but in the past year accounted for 80% of the growth. Those will continue to be the growth vehicle’s going forward, as the company continues to prune its fixed assets in the PB and Williams-Sonoma banners. We’d argue that those are the two most important assets to the long term health and profitability of the company. And, the numbers speak for themselves…as the core business slows so too does the profitability of the parent company. Organic growth from non-core parts of the business is perfectly healthy, but to have 80% of the business headed into the tank for a company that needs mid-to-high single digit comp growth in order to keep operating margins steady strikes us as particularly bearish.

WSM | Really Don't Like It - WSM 80 20 chart2

 

The Wayfair Disruption: The home furnishings market in the US is highly fragmented, with no player in the space in excess of 6% share of its respective market in the brick and mortar channel (Wayfair is tops at over 10% of the online channel). So, this isn’t necessarily a market share battle pitting WSM vs. W, when over 80% of the market is still comprised of mom and pop operators. Is W pulling some dollars out of WSM’s pocket? We think the answer is most definitely yes, but what might even more troubling to the WSM management team is the need to compete with a company with an operating margin in the red. That defines deflationary environment, and the company has all but confirmed that it would play the game as it talked to the need to emphasize lower cost items in its Pottery Barn brands on its most recent call in March. “We'll strategically expand our mix of opening price points across key areas of the business and highlight these price points to attract a broader customer base”.

 

The numbers speak for themselves, as Wayfair has taken a disproportionate share of the online furnishing spend, with over 1/3rd of the incremental online furnishing spend over the past year. If we pull back the timeline an additional 12 months, the numbers stack up like this: WSM $400mm added online over the past 24 months and Wayfair 3x that at $1.3bn. With 75% of WSM’s growth coming from online over the past 5 years, the addition of competent (yet unprofitable) competitor with no bottom line to protect makes things much more difficult going forward.

WSM | Really Don't Like It - 5 17 2016 W   of online growth

 

Not only have we seen the pressure in the reported numbers, but when we dig a little deeper into the customer visitation behavior online, we can see a high overlap in visitation between the two sites. That number is trending up, with the customers visiting both sites (Wayfair and WSM’s family of brands) in the first quarter months of Feb-Apr up ~350bps.

WSM | Really Don't Like It - WSM W Overlap chart4

 

Few Levers Left To Pull: Since the dark-days of 08-09 we’ve seen gross margins recover from recession lows to just shy of 40%. What’s more important is the composition of that expansion. Primarily a) 410bps of occupancy leverage as the company culled its portfolio and renegotiated lease terms with landlords through and out of the recession, and b) 470 bps of product margin/fulfillment deleverage as the online penetration went from  41% in 2010 to 51% in 2015. The occupancy lever has dried up over the past 3 years as the company pushes into more expensive international wholly owned stores – the offset to that is closing stores, but that will impact the e-commerce channel. Product margins will continue to drift lower as e-commerce and international (lower gross margin) carry the bulk of the growth, with an additional whack coming from fulfillment expense (see 2nd chart below).

 

Some of that will be made back on the SG&A side, but it’s difficult to see where additional cost savings will come from that are needed to offset the decline in gross margins. Corporate G&A is as lean as its been during this economic cycle at 6.3% of sale and is headed lower after the 5% workforce reduction announced on the 4Q call. Distribution expenses continue to creep higher, and the company is investing heavily in a new DC at the tail end of an economic cycle. Add on the lower profitability push into international, and it paints a bearish picture for margin health over the near and long term.

WSM | Really Don't Like It - WSM GM chart5

WSM | Really Don't Like It - WSM Margin e comm chart6

 

Quarter Considerations: We think the quarter the company is set to report on Wednesday looks fine. The company has never missed a 1st quarter print during this economic cycle and given the short window between guidance and the end of the quarter (just 6 weeks) we think the bar at flat to HSD EPS growth is hittable. Though the one thing that stood out to us is the decelerating e-commerce metrics being posted by the entire portfolio of brands. That’s been evidently clear in the reported DTC growth numbers coming down from 14% in the back half of ’14 to just 3% in 4Q15. Visitation metrics have continued to decelerate through 1Q16.

WSM | Really Don't Like It - 5 17 2016 chart7


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  • Bullish Trend
  • Bearish Trend
  • Neutral

INDEX BUY TRADE SELL TRADE PREV. CLOSE
UST10Y
10-Year U.S. Treasury Yield
1.80 1.70 1.75
SPX
S&P 500
2,038 2,082 2,066
RUT
Russell 2000
1,098 1,126 1,116
COMPQ
NASDAQ Composite
4,682 4,799 4,775
NIKK
Nikkei 225 Index
16,011 16,820 16,466
DAX
German DAX Composite
9,794 10,068 9,952
VIX
Volatility Index
13.55 17.43 14.68
USD
U.S. Dollar Index
93.11 94.99 94.55
EURUSD
Euro
1.12 1.15 1.13
USDJPY
Japanese Yen
106.44 109.99 109.07
WTIC
Light Crude Oil Spot Price
45.16 49.13 48.61
NATGAS
Natural Gas Spot Price
1.96 2.22 2.03
GOLD
Gold Spot Price
1,258 1,295 1,275
COPPER
Copper Spot Price
2.03 2.13 2.09
AAPL
Apple Inc.
89.99 95.01 93.88
AMZN
Amazon.com Inc.
657 720 710
MCD
McDonald's Inc.
127 132 129
XLU
Utilities Select Sector SPDR
48.41 49.92 49.45
GOOGL
Alphabet Inc.
700 740 730
FB
Facebook Inc.
116 121 118


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