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Is The Healthcare Bubble About To Burst?

In this brief excerpt from The Macro Show, Hedgeye CEO Keith McCullough and Demography Sector Head Neil Howe respond to a subscriber’s question about whether the healthcare sector is a bubble that’s about to pop.

 


TGT/WMT | Backyard Brawl

Takeaway: WMT investing as TGT sits on the sidelines. Competitive dynamics continue to intensify, TGT the clear loser.

This evolving TGT/WMT relationship has all the makings of a backyard brawl. The only problem is…it’s not a fair fight. Don’t get us wrong – it could be, but as highlighted in our note following the TGT print (full note: TGT | Losing at Defense), we think the management team at Target is playing defense – badly. Think the ‘rope-a-dope’ without the Ali endurance or uppercut. That’s at the same time that the competitive dynamics around the retailer are evolving faster than at any point we can remember in large-cap retail.

 

In one corner you have AMZN scooping up 25% of the incremental dollars up for grabs in US retail – that’s 2x the rate we saw at the same time in 2015. In another corner is WMT, who saw a meaningful traffic inflection starting in 1Q14 and has been able to hold the upward trajectory for 2+ years as it invests its way to a flat earnings CAGR over the next 4 years. And in the 3rd corner there’s TGT, who has effectively managed expenses to hit near term expectations at the expense of long-term share, with no clearly articulated plan to win in any environment and a stunning lack of insight as to why the business is struggling in the face of otherwise solid prints by its two closest competitors.  

 

In the series of charts below, we walk through what we think are the key callouts from the evolving TGT/WMT relationship and why we think TGT is the ultimate loser in this royal rumble. That will ultimately manifest itself in either a) lost market share and pressured margins taking earnings into the mid-$4s, or b) a meaningful reset in expectations as the company doubles down on the investment line to compete with its peer group.

 

WMT Out-Trafficking TGT

We positioned this chart first in the queue because we think it clearly demonstrates that WMT is winning what we coined the ‘backyard brawl’. To be clear, this is the effect and not the cause of the broader strategic decisions each team is making in order to ultimately drive traffic and win market share. There has been a clear deviation in the trend, with the spread between the two opening up to 1.2% in 1Q and 3.4% in 2Q, both in favor of Walmart. The most recent metric is good for the biggest spread we’ve seen since the TGT data breach in 4Q13, and the widest gap over the past 5 years in a normal environment. Most importantly, we don’t think this a near term statistical aberration, as WMT is putting the dollars behind the up-tick in traffic which will continue to propel outperformance while TGT sits on the sidelines.

TGT/WMT | Backyard Brawl - 8 18 2016 WMT TGT Traffic

 

Two Different Investment Cycles

This is the cause we referred to earlier, as we’ve seen a huge investment spread open up between TGT and WMT. It started back in mid-2014 around the same time Cornell started his tenure in Minneapolis, and has held steady at nine-points over the past two quarters. That’s important given that Cornell is now two years into his tenure at TGT, and now has his team and strategy in place. Based on what we’ve seen to date, it can be characterized by prudent decision making when it comes to cutting Canada/Rx biz and a reluctance to spend in order to keep pace with the competition. Ultimately, we think the spread between the two needs to change dramatically – and that’s not going to be gifted to TGT from WMT as the latter company has a free pass to invest after it lowered expectations 10 months ago. That means either TGT needs to open its pockets or be content with taking what comes its way.

TGT/WMT | Backyard Brawl - wmt tgt sga

 

WMT Lean, TGT Bloated

The SIGMA trajectory for each company couldn’t be more different. For WMT: we are looking at a sales/inventory spread of 5% in the US which is a positive set-up for GM going forward and this leverage should continue to offset some of the SG&A pressure felt from investments. For TGT: inventories are building into a slowing sales guide, which we think could add additional pressure on GM in addition to the e-commerce headwind and promotional pressure already being felt.

TGT/WMT | Backyard Brawl - 8 18 2016 WMT TGT SIGMA

 

Win For TGT

This is the one metric where we will declare victory for TGT in 2Q. Though at 16% growth it’s not going to win a medal. There have been flashes of brilliance over the past 18 months for TGT, but not the sustained growth at a 40% CAGR that management thought was achievable 18 months ago. The key here is that while TGT continues to pull back on capital outlays to fund its e-commerce growth both on the P&L and the balance sheet, WMT went out and spent $3.3bn to acquire talent and technology in the form of Jet.com. The ante chip to compete for brick and mortar retail just went up tremendously.

TGT/WMT | Backyard Brawl - 8 18 2016 WMT TGT Ecomm Spread


PREMIUM INSIGHT

Gloom & Doom? No. But Short Healthcare On #ACATaper

Gloom & Doom? No. But Short Healthcare On #ACATaper - stormy

Pick your poison. Whether we’re talking about Fed rate hikes, leverage, slowing utilization or job openings, all spell trouble for Healthcare.


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.46%
  • SHORT SIGNALS 78.35%

INSTANT INSIGHT | An Update On Spain, The ECB & #EuropeImploding

Takeaway: Spanish political drama leaves investors in the dark. Meanwhile, we suggest investors continue to fade the easy yet ineffectual ECB policy.

INSTANT INSIGHT | An Update On Spain, The ECB & #EuropeImploding - Spain cartoon 06.30.2016

And the political pain continues in Spain.

 

The latest update is acting PM Rajoy has once again convoluted the road to forming a government, this time going against his word to evaluate a series of reform demands from the centrist Ciudadanos party (which if agreed to by Rajoy would increase the likelihood of Ciudadanos joining Rajoy’s party to form a coalition government). Will this political indecision continue, leaving investors in the dark? 

 

You bet!

 

It has been for some time. Take a look at the Spanish IBEX's performance below.

 

INSTANT INSIGHT | An Update On Spain, The ECB & #EuropeImploding - spain bubble peak

 

On a related note, ECB Minutes from July 21 show continued use of phrase “it [ECB] would act by using all instruments available within its mandate.” We continue to fade the ECB policy stance that QE will fix the region’s underlying growth and inflation ails. Our short bias on the EUR/USD remains intact.

#EUROPEIMPLODING.

 

***Editor's Note: The snippet above is from a note written by our Macro team and sent to subscribers this morning. Click here to learn more.


Macrocosm 2016 | Important Date Change!

We are changing the date of Macrocosm 2016 to Wednesday, November 16th in light of a religious calendar conflict. The good news is that America will have just elected a new president. Our speakers will discuss the Election Day outcome and its implications for investors around the globe.

 

In the coming weeks, we will release our full speaker roster and how to reserve your spot at this exclusive investor event.

 

The event will be held at the Yale Club of New York City.  Please mark your calendar now – November 16th!  

 

-Your Macro Team

 

Macrocosm 2016 | Important Date Change! - macrocosm2016 banner graphic email


FL | Confident in Short Across Durations

Takeaway: This short call has legs as returns get cut in half over 2 years. If FL manufactures EPS tomorrow, short more.

For over a year we have been vocal on how the changing paradigm in how shoes are designed, sourced, manufactured, and sold is radically changing up the Athletic Footwear industry as we have known it for 40+ years. To be clear, this goes far beyond the simple 'content owners (NIke, UA, Adidas, etc...)' win, and traditional distribution loses. Everyone has a license to win, or lose. All it takes is a vision, talent, a boatload of capital, and the mandate to deploy it.

 

In that context, Nike is the clear winner, which is no surprise. But we think that people grossly underestimate both the depth and duration of its share gain and boost in profitability. Foot Locker is nearly the exact inverse, characterized by declining sales, weaker margins, higher SG&A, more working capital, Capex grinding higher (but not high enough to win strategically), and RNOA going from 28% (where it is today) to something in the low-mid teens. Stocks don't go up when RNOA gets cut in half -- even if they 'look so darn cheap on consensus earnings and trailing cash flow'.

 

To be clear, this kind of call does not play out in a single quarter. That is not a 'weak conviction hedge' into tomorrow's FL print. Not by a long shot. We fully expect the print to reinforce our 'declining return' theme -- with better than 90% confidence. Could the company find a way to make the stock go up on the day? Of course. Companies always can. But either way, every bit of research in our arsenal says that this is a name we want to be short right here, and right now. 

 

DETAILS

We’ve seen some of of our call play out to date – but only some. Mostly in the stock price…off 7% YTD vs. the XRT +5%, rather than the reported earnings numbers. The call has worked, but not for all the right reasons, yet. We’ve seen multiple compression and now we think it’s time to start seeing it in the form of earnings revisions. Maybe not tomorrow, but certainly before the year is out. This is a 3 steps forward and one step back kind of short – and one that will ultimately lead to earnings closer to $3, which is significantly below where just about anyone thinks they could go.

 

Thinking about the near-term considerations, we saw the first hiccup from this company three months back in the form of a comp number that slowed by 400bps sequentially on a 2yr run rate and EPS growth of 7%, good for the lowest rate we’ve seen since 2009. It was also a watershed moment in the FL/NKE relationship as management at the former was as bearish on its key partner as we can ever remember. It hasn’t quite been a soap opera since, but there is a slew of data points that we think are particularly bearish for FL. Including…

 

a) Nike basketball growth went negative for Nike in FY16, though with Jordan the growth rate for the year was 11% down from 19% in 2015.

b) Nike readjusted the price/valuation equation at the tippity top of the pricing spectrum for its KD and Lebron shoes, taking the new model price points down 17% and 13%, respectively. That’s key given that much of the comp number is driven by ASP growth given that FL is smack dab in the middle of the negative traffic mall.

c) Nike wholesale growth went from a pretty consistent run rate between 10-15% to flat in the quarter the company closed in May.

d) Nike incremental wholesale dollars slowed to $431mm in the company’s FY16, 40% the average rate we’ve seen over the past 4 years. Assuming a 20% DTC growth rate for Nike in FY17, which we think could prove to be on the low end, means the wholesale dollars up for grabs are set to be cut in half again.

 

None of the above is a good barometer for FL. We’re short it. There’s no way FL comes out of this smelling better than it does today. Sales should weaken, gross margins should decline, SG&A and capex will BOTH head higher as FL tries to build up a more successful e-comm business to compete with its existing partners. Management is good at FL, and it will spend where it needs to – and after its Nike business went from 50% to 73% of revs over six years it really did not have to invest at all (hence unsustainably low SG&A). Now that changes.

FL | Confident in Short Across Durations - 8 18 2016 FL earn table B 

 

Near Term Considerations:

 

After 3 years of nearly bulletproof earnings prints (FL has gone 11 straight quarters meeting or exceeding street numbers), we believe FL will be hard pressed to hit current 2016 estimates. Here’s why:

 

Revenue

1. Jordan launch timing was the signaled to be the key perpetrator for the negative comp trend QTD and while we aren’t blind to the factor launch timing can have on the weekly cadence of comps, but we think the softness in Nike basketball is a bigger headwind to overcome. The latter part we think helps explain the 500bps deceleration in comps from 4Q15 to 1Q16.

2. In this last fiscal year, NKE reported Nike Basketball and the total Jordan Brand separately for the first time. Jordan Brand grew 18% for FY16 on top of +20% in 2015, while Nike Basketball was DOWN 1% on top of +18%. While we think there is some obvious shift in demand from Nike to Brand Jordan, it’s the aggregate basketball business that really matters for FL. Basketball slowed to negative mid-single digits in 1Q16 vs a tough low double digit compare, and it doesn’t get any easier up against DD growth again back in 2Q15.

3. Comps were negative QTD as of the FL call on May 20th with street expectations for a 3.8% comp in the quarter. That means we would need to see a of 500bps+ intra-quarter acceleration in the trend in order for FL to hit current estimates. If history is any indication, FL has a pretty big mountain to climb. In order to hit a 4% comp this quarter, FL would have to see the biggest acceleration in… well, ever (or at least during this economic cycle). Then, from here, comps don’t get easier.

4. Don’t be fooled by positive QTD sales commentary on the call. August of 2015 was a relatively easy compare at mid-single digits, while September and October compares jump to double digits.

FL | Confident in Short Across Durations - 8 18 2016 NKE Bball

 

Margin Considerations

Merchandise margin compares get tougher sequentially from 1Q when the company missed comp by 160bps and gross margin by 30bps. ASP resistance has been well documented, and compares aren’t getting any easier from here. That’s an important point, as FL needs a low mid-single digit comp to leverage occupancy and about the same on SG&A. The FX SG&A tailwind is now completely gone with certain investment buckets weighing on 2Q in particular. Rounding it all out, the 1Q sales to inventory spread, though still positive, hit its worst level in 9 quarters. Throw in the liquidation of ~3mm pairs of athletic footwear between TSA and Sport Chalet in 2Q, and we think margins are more likely to surprise to the downside than the up.

FL | Confident in Short Across Durations - 8 18 2016 FL Sigma


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