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KR | 3Q16 EARNINGS NOTE | SOMETHING HAS TO GIVE

Kroger (KR) is on the Hedgeye Consumer Staples SHORT bench.

 

HEDGEYE OPINION

Kroger reported lackluster figures today, as the business continues to struggle through a deflationary environment, resulting in tighter margins and decreased ROIC; and adding to the headwinds are increased competition and continued pressure from their multiemployer pension plans (MPP). Kroger is in a position where they are destroying shareholder value with the hopes of moving the company and the brand forward. With sales, margins and returns all decelerating, the company is not adjusting to the new operating environment.  In addition, Kroger has its hands tied with its MPP’s which are increasingly impactful to the business. In order to add relevant value to the business, management will have to be smart in reallocating savings to value-added areas that improve the experience for consumers.

 

ID SSS came in at +0.1%, after trending at +0.5% near the end of the quarter, missing FactSet estimates of +0.5% and gross margin was 22.2% versus FactSet 22.2%. EPS was $0.41 for the third quarter, matching FactSet estimates. For the remainder of the year, the Company narrowed their EPS guidance to a range of $2.10 - $2.15 (excludes the $0.07 charge from 2Q), down from their prior guidance of $2.10 - $2.20.

 

The next big data point for the company will come when management outlines its official guidance for FY17.  Management has alluded that FY17 will be the second year in a row that it will not hit its long-term EPS guidance of 8-11%.  Without significant changes to the operating environment it will be difficult for the company to get the low end of the range over the next couple of years; if ever!   

 

Our bearish bias to KR is tempered by our bullish bias to the grocery retail space.  We expect the entire grocery space to trend upward as we enter a reinflationary environment. However, of all of the names in the space, Kroger faces the most fundamental issues, the most important of which is their multiemployer pension plan obligation, followed by their tightly wound business model. Their MPP obligation will continue to be a drag on the business, and there are many aspects of the financials that are not sustainable.  We will provide further detail of this in a more detailed note that is forthcoming. 

 

NOTABLE COMPANY THOUGHTS

“It’s worth noting, over a longer time horizon we do expect our net total debt to EBITDA ratio to grow if we continue to successfully negotiate restructuring of troubled multiemployer pension plan obligations to help stabilize associates’ future benefits,” (Michael Schlotman, CFO).

HEDGEYE After taking their $0.07 EPS charge in relation to the restructuring of certain MPP obligations last quarter, the company appears to be giving us a heads up that there is more coming down the pike.

 

“When we take on additional debt to fund these obligations, this reduces the off balance sheet amount of estimated multiemployer pension plan obligation,” (Michael Schlotman, CFO).

HEDGEYE – Surprisingly, the Company provided much more MPP information than they have on previous calls. Such information further solidifies our SHORT bias.

 

“As expected, deflation persisted during the third quarter, and as we’ve said before, transition periods created a difficult operating environment. This is the third time we’ve had such deflation in 30 years and in previous instances, deflation lasted from 3-5 quarters in a row…We are in the middle of the cycle right now,” (Rodney McMullen).

HEDGEYE This statement mirrors the guidance provided prior to the call, with KR expecting the operating environment in the first half of 2017 to be “similar to today.”

 

On their approach to e-commerce: “Where we’re situated, our customers live within two or three miles of the store. They more regularly shop in. It’s extremely convenient for them to order online and make that stop by the store on their way to and from either work or daily activities,” (Michael Schlotman, CFO)

HEDGEYE When pressed on whether they would pursue home delivery, as some competitors have done, management did not take the bait. According to management, ClickList has allowed them to gain share while offering added convenience to their customers.

 

QUICK COMPS

  • Revenue: $26.56B vs FactSet $26.33B
  • 3Q EPS:$0.41 vs FactSet $0.41
  • IDs (ex-fuel): +0.1% vs FactSet +0.5%
  • Gross Margin: 22.2% vs FactSet 22.2%
    • Ex-fuel: -5bps
    • OG&A: 16.7% vs FactSet 16.5%
      • Operating expenses ex-fuel: +19bps (15bps of this is related to depreciation increases in capital program)
      • Operating Margin: 2.7% vs FactSet 2.7%

 

KR | 3Q16 EARNINGS NOTE | SOMETHING HAS TO GIVE  - Chart 1

 

 

OUTLOOK

Q4 Guidance:

  • Company expects slightly positive identical supermarket sales growth (ex-fuel).

 

FY16 Guidance:

  • Adjusted EPS $2.10 - $2.15 vs FactSet $2.13 (prior guidance of $2.10 - $2.20).
  • Expected capital investments $3.6B - $3.9B.

 

FY17 Guidance:

  • The Company is completing its business plan process for 2017 and will provide specific 2017 guidance in March.
  • KR anticipates both positive identical supermarket sales and net earnings per diluted share growth (excluding the 53rd week).
  • Net earnings will likely be below the low end of the company’s 8-11% net earnings per diluted share long-term growth rate guidance.
  • KR expects the operating environment in the first half of 2017 to be similar to today. The second half of 2017 should show improvement as the company laps current figures.
  • The Company is committed to achieving a net earnings per diluted share growth rate of 8-11%, plus a growing dividend.

 

Please call or e-mail with any questions.

 

Howard Penney

Managing Director

 

Shayne Laidlaw

Analyst


What the Media Missed: OPEC's Toothless Deal to "Cut" Oil Production

Takeaway: The mainstream media said yesterday's OPEC announcement was a "landmark deal to reduce oil output." History suggests otherwise.

What the Media Missed: OPEC's Toothless Deal to "Cut" Oil Production - gullible

 

Oil prices have surged over 10% since OPEC announced a deal to "cut" oil production. We'll get to the complete nonsense of it all below. For the record, the 14-member country oil cartel controls one-third of global oil production and sits on 80% of global crude reserves. So, it wasn't surprising that the mainstream media heralded yesterday's announcement as a "landmark deal to reduce oil output."

 

Here's the Wall Street Journal's summation:

 

"OPEC representatives reached a landmark deal to reduce oil output, propelling crude prices more than 8% after months of wrangling and market uncertainty about the ability of the once-mighty group to strike an agreement. The Organization of the Petroleum Exporting Countries said Wednesday that it would cut production by 1.2 million barrels a day from 33.6 million barrels and said it expects producers from outside the group, including Russia, to join with additional cuts totaling 600,000 barrels a day."

 

Hang on a second. Time for a reality check.

 

OPEC has had virtually no impact on how much oil its members produce. While it sets quotas, its member countries cheated about 96% of the time from 1982 to 2009. That's according to a study by Brown University professor Jeff Colgan.

 

Our Senior Energy Policy analyst Joe McMonigle adds:

 

“Even OPEC assumes cheating, which is why they established a compliance committee (although it's toothless).”

 

In addition, yesterday's deal to cut oil production relies heavily on Russian involvement. The country's energy ministry has already said it would "gradually" work up to the deal cuts, as McMonigle pointed out yesterday. In other words, "the deal is already on shaky ground," he says.

 

Back to Colgan's OPEC study. Here are a few of the more interesting findings:

 

  • OPEC announcements have an ability to move spot prices for 15 to 20 days. but there is exactly zero evidence OPEC is actually restricting output during this time
  • On average, over this 1982 to 2009 period, the nine principal members produced on average 10% more oil than their quotas supposedly allowed
  • The relationship between oil prices and OPEC quotas is virtually uncorrelated (r^2= 0.15)
  • All but two members over-produced in more than 80% of the months during this period. The exceptions were Iran and Venezuela, which still cheated over 70% of the time
  • There were 22 OPEC meetings in that same period in which quotas were increased, and in 21 cases, the new aggregate quota for the 9 principal member was lower than what those countries were producing a month prior to the change

Bottom Line

This OPEC "deal" pays lip service to a cut in oil production. History strongly suggests this is yet another toothless OPEC commitment that won't be honored. 


Poll of the Day: Will OPEC Members Cheat on Pledged Oil Production Cuts?

Takeaway: What do you think? Cast your vote. Let us know.

Poll of the Day: Will OPEC Members Cheat on Pledged Oil Production Cuts? - opec headq thumb up down

 


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4 Reasons to Sell Carnival | $CCL

4 Reasons to Sell Carnival | $CCL - ccl

 

Our Gaming, Lodging & Leisure analyst team recently added Carnival Cruise Corporation (CCL) to the Hedgeye Best Ideas list as a short. Carnival is an American-British cruise company and the world's largest travel leisure company. It has a combined fleet of over 100 vessels across 10 cruise line brands.

 

The stock has outperformed and now resides close to a 52 week high. We view the valuation as full, to say the least, particularly in the face of a potentially disappointing 2017. 

 

Industry veteran Todd Jordan will explain his team's bearish thesis in a slide deck presentation at 10am ET today. 

KEY POINTS OF DISCUSSION

  1. GROWING RISKS IN CHINA – Our September trip to China revealed that the risks to pricing may be more severe than previously thought. That thesis is now bolstered by the latest installment of the China pricing survey which suggests even lower pricing for the winter season (Q4 2016-Q1 2017) for the market in general and CCL’s brands in China (Costa and Princess). We’ll take you through the numbers and why we think pricing and profitability could deteriorate further.
  2. WAVE 2017 COULD DISAPPOINT – While we’re not projecting negative Caribbean yields for 2017, we think Wave season faces some big hurdles not appreciated by the Street. A disappointing Wave would result in disappointing 2017 yield growth and EPS. Our slide deck and conference call will lay out the prospects for Wave and yield implications.
  3. EXPENSIVE VALUATION/2017 ESTIMATES TOO HIGH – CCL looks expensive to us, particularly with the risks we see and a suppressed growth rate and lower margins in China. The stock has done well recently and sell side sentiment is bullish. Management's forward looking commentary has helped but in the pre-Wave period and with short booking windows in China, there is limited visibility to the risks we see. We're solidly below on 2017 yield and EPS estimates.
  4. OTHER CONSIDERATIONS – We think the Street is missing a few other issues as well which we will address during the conference call

 

Attendance on this conference call is limited. Ping sales@hedgeye.com for more information.


Did OPEC Just Bail Out Struggling U.S. Oil Frackers?

Did OPEC Just Bail Out Struggling U.S. Oil Frackers? - oil frack

OPEC's Deal is Great for Struggling U.S. Frackers.

 

OPEC announced with great fanfare yesterday that its 14-member countries would cut oil production. The news boosted oil prices over 9%. It's up another 3% today to over $51/barrel. (Click here to read our take on the OPEC news.)

 

Lower oil prices since 2014 peaks have helped OPEC break the backs of the U.S. fracking industry. As you can see in the Chart of the Day below, domestic capital spending on oil-related projects ramped for many years into the 2014 peak. That bubble doesn't deflate in a year. It has fallen along with oil prices ever since.

 

However, U.S. production has shown resiliency in the $40-$50 range. Over the last two quarters, domestic frackers digested the macroeconomic reality of lower prices and have become more efficient. In other words, OPEC's announcement is seemingly a positive on the margin for domestic producers which could prolong this re-balancing process and the real physical market impact into 2017O

 

here's the reality for U.S. domestic Oil producers:

 

  • Domestic crude inventories are up +6.8% year-over-year.
  • The pace of the build has decelerated since the beginning of 2016 where crude inventories were tracking +30% year-over-year
  • At +6.8%, that still outpaces steady demand trends for refined products after putting in post-recession lows.

 

We'll be watching to see how this all shakes out heading into the 2017 spring refining season but OPEC may have thrown domestic oil producers a bone.

 

Did OPEC Just Bail Out Struggling U.S. Oil Frackers? - 12.01.16 EL Chart

 

 


PREMIUM INSIGHT

3 Reasons Why We’re Bearish On Regional Gaming Stocks

3 Reasons Why We’re Bearish On Regional Gaming Stocks - TMS TJ Gaming  11 28 2016 no text

A perfect storm of trends is looming large over regional gaming stocks. Public companies like Boyd Gaming, MGM Resorts and Penn National Gaming are all in the storm’s path according to Hedgeye Gaming analyst Todd Jordan. 


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%
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